CA Pranav Dedhia - Costing Theory Smart Notes (CA Inter)

CA INTER
Costing Theory Smart Notes
CA Pranav Dedhia
Dear Friends,
It is often noticed that most of us ignore the theory part in Paper 3 – Cost & Management Accounting. However,
every examination paper always has conceptual theory questions to verify our understanding of the subject as a
whole.
Theory portion plays a key role in Paper 3. Even in the toughest of C&MA Examination papers, if nothing works,
then surely theory will work. Weightage of theory portion usually remains 20-25 marks, but generally we find at least
16-20 MARKS of theory in every examination term.
It is true that we find it difficult to manage this part of the paper during our study time as it ends up becoming too
time consuming and we lack confidence to be able to reproduce in examination; as a result of which it goes skipped.
However, theory part is VERY EASY and SCORING. In fact, it acts as a TIME SAVER to complete the paper. Also,
it leaves a good impression on the examiner that the candidate is well aware of key theory concepts that often are left
unanswered by most candidates.
“Costing Theory Smart Notes” is an attempt to explain all the key theory concepts in this paper in a Summarized
form in JUST 16 PAGES. It contains some memory techniques to retain these concepts and be able to reproduce
them in the examination. The keys/codes/memory techniques may not make sense or appear funny, but TRUST ME,
the funnier it gets, the more you will be able to recall.
Care has been taken to avoid mistakes while compiling this booklet. Students may post their suggestions and feedback
by writing to me at capranavdedhia@gmail.com.
I hope this booklet helps you all to quickly revise and get a good hold over Costing Theory.
All the BEST for your Career
Happy Reading!!
CA Pranav Dedhia
This booklet is not for sale

Sr No
Contents Page
1 Introduction to C & MA 1.1 to 1.4
2
Material Cost 2.1 to 2.3
3
Employee Cost & Direct Expenses 3.1 to 3.2
4
Cost Accounting System 3.2
5
Overheads 4.1
Contents 6
Activity Based Costing 5.1
7 Unit Costing, Batch Costing & Job Costing 6.1
8
Joint Products & By Products 6.1
9 Contract Costing & Process Costing 7.1
10 Standard Costing & Marginal Costing 8.1
11
Budget & Budgetary Control 9.1
12
Operating Costing 9.2
Introduction to Cost and Management Accounting
Cost A/Cing & its Objectives Scope of Cost A/Cing Role and Functions of C&MA Essentials of a Good Cost A/Cing System Installation of Cost A/Cing System – Factors
“The process of A/Cing for cost which begins (Key : C²A²RS) Role: (Key : I Am Ultra FIT) (Key : SIMON IS Highly Powerful Personality)
with recording of income & expenditure or  Cost Comparisons: Includes  Provide relevant info. to mgmt.  Informative and simple: Should be tailor-  Statutory compliances and audit: Records are to be
basis on which they are calculated & ends with comparisons of cost from for decision making. made, practical, simple & capable of maintained to comply with statutory requirements &
preparation of periodical statements & reports alternative courses of actions  Assist management for planning, meeting requirements of business. applicable cost accounting standards to be followed.
for ascertaining & controlling costs” such as use of different measurement, evaluation &  Accurate and Authentic: Data should be  Information Attributes: Information generated from Costing
technology for production, cost control of business activities. accurate & authenticated; otherwise it system should possess all attributes of information i.e.
Objectives (Key : CARDS) of making different products &  Help in allocation of cost to may distort system’s output. complete, accurate, timeliness, relevant etc.
 Cost Control: Maintaining discipline in activities & cost of same product products & inventories for both  Uniformity & Consistency: Uniformity &  Method of maintenance of cost records: Manner in which
expenditure is an imp. obj. It ensures that / service over a period of time. external & internal users. consistency in classification, treatment & Cost & Financial Accounts could be inter-locked into a single
expenditures are in consonance with  Cost Control: Same as Alongside Functions: reporting of cost data & related integral accounting system & how results of separate sets of
predetermined standards & variation is  Cost Accounting: Same as  Collection & accumulation of cost information is required for benchmarking accounts i.e. cost & financial, could be reconciled by means
reported. Alongside for each element of cost. & comparability of results. of control accounts.
 Ascertainment of Cost: Costs are  Cost Analysis: Involves process of  Assigning costs to cost objects to  Flexible & adaptive: Should be flexible  Objective: Objective of costing system, viz. whether it is
accumulated, assigned & ascertained for finding out factors responsible ascertain cost. enough to make necessary amendments being introduced for fixing prices or for insisting a system of
each cost object. for variance in actual costs from  Budgets & Standards are set for to incorporate changes in technological, cost control.
 Cost Reduction: Achievement of real & budgeted costs & fixation of particular period or activity reporting, regulatory & other  Nature of Business: Every business has its own peculiarity &
permanent reduction in unit cost of responsibility for cost beforehand which are compared requirements. objectives. According to its info. Requirement, cost
goods manufactured or services rendered differences. with assigned costs. Deviations  Integrated & inclusive: Should be accounting methods are followed.
without impairing their suitability for  Cost Reports: Ultimate function are reported. integrated with other systems like  Information Synchronisation: While drafting a costing
intended use or diminution in quality. of cost a/cing. Reports are  Provision of relevant information financial A/Cing, taxation, statistics & system, information needs of various other departments
 Assisting mgmt. in Decision Making: primarily prepared for use by to mgmt. for decision making. operational research etc. to have should be taken into account.
Assists mgmt. in planning, implementing, mgmt. at different levels. Cost Management Information System complete overview & clarity in results.  Organisational Hierarchy: Should fulfil info. requirements of
measuring, controlling & evaluation of Reports helps in managerial (MIS) provides relevant & timely  Trust on the system: Mgmt. should have different levels of mgmt.
various activities by providing relevant decision making. information. trust on system & its output. An active  Knowing the Product: Nature of product determines type of
information.  Statutory Compliances :  Function of cost & mgmt. a/cing is role of mgmt. is required for costing system to be implemented.
 Determination of Selling Price & Maintaining cost a/cing records to gather data like time taken, development of such system that reflects  Knowing the Production Process: Cost apportionment can be
Profitability: Helps in determination of relating to utilization of wastages, process idleness etc, a strong conviction for decision making. done on most appropriate & scientific basis if a cost
selling price & profitability of cost materials, labour & other items analyse data, prepare reports & accountant can identify degree of effort or resources
objects. Basis for price fixation & rate of cost as per rules prescribed by take necessary actions. N‘12 consumed in a particular process.
negotiation. statute. (4m)
Notes
Costing Theory Smart Notes (CA Inter)

Compiled by CA Pranav Dedhia Private Tuitions for CA & Commerce Students 99 20 625 985 1.1
Responsibility Centres Controllable Cost Differential Costs Out-of-Pocket Costs Shut Down Costs Absolute Costs
(i) Cost Centres are held accountable for  Cost that can be controlled, typically by a  Represents change in total cost  It is that portion of total  Costs which continue to  Refer to cost of any product,
M‘15 incurrence of costs which are under its cost, profit or investment centre manager. due to change in activity level, cost, which involves cash be incurred even when a process or unit in its totality.
(4m) control. Performance is measured against pre- technology, process or method of outflow. plant is temporarily  When costs are presented in
determined standards or budgets. Two types:  Controllable costs incurred in a particular production, etc. AKA Incremental  Short-run concept used in shut-down, viz. Rent a statement form, various
(a) Standard Cost Centre where output is responsibility centre can be influenced by & Decremental costs. decisions relating to fixation rates depreciation cost components may be
measurable & input required for output can be action of executive heading that centre.  Eg. If any change is proposed in of selling price in recession,  Cannot be eliminated shown in absolute amount
specified. existing level or method of make/buy with closure of plant i.e. or as a percentage of total
(b) Discretionary Cost Centre whose output cannot  For eg., direct costs comprising direct production, increase or decrease  These costs can be avoided all fixed costs, which cost
be measured in financial terms, thus input- labour, direct material, direct expenses & in total cost will be known as if a particular proposal cannot be avoided  Such costs are base costs on
output ratio cannot be defined. some overheads are generally controllable incremental cost or decremental under consideration is not during temporary which further analysis &
(ii) Revenue Centres are accountable for by shop level mgmt. cost. accepted. closure of plant decisions are based.
generation of revenue. Though revenue M’15
M‘15
centre does not have control on expenditure, Uncontrollable Cost Imputed Costs M‘18 Opportunity Costs (2m) Sunk Costs Capitalised Costs
it incurs expenditures related with selling (2m)
activities like commission to sales person etc  Costs which cannot be influenced by  Notional costs which do not  Refers to value of sacrifice  Historical costs  Costs which are initially
(iii) Profit Centres have both responsibility of action of a specified member of an involve any cash outlay. made or benefit of  Play no role in decision recorded as assets and
generation of revenue & incurrence of undertaking.  Interest on capital, payment for opportunity foregone in making in current subsequently treated as
expenditures. Profitability is the basis for  For example, expenditure incurred by tool which is not actually made, is an accepting an alternative period. expenses.
measurement of performance. room is controllable by foreman in-charge eg. of imputed cost. course of action.  Eg. In case of decision
(iv) Investment Centres Not only responsible for of that section but share of tool-room  These costs are similar to  Eg. Withdrawal of FD to relating to replacement
profitability but also have authority to make expenditure which is apportioned to a opportunity costs. finance expansion. Loss of of machine, WDV of
capital investment decisions. Performance is N ‘09 existing machine is sunk N ‘09
machine shop is not to be controlled by interest on FD is opportunity
measured on basis of ROI besides profit. (2m) cost (2m)
machine shop foreman. cost for expansion
Limitations of Cost A/Cing Discretionary Costs Explicit Costs Implicit Costs Engineered Costs Product Costs Conversion Costs
 Expensive : It is expensive because analysis,  Costs which are not tied  AKA out of pocket  Do not  Costs that result  Costs which are associated  It is the cost of transforming basic
allocation and absorption of overheads require to a clear cause & effect costs & refer to involve specifically from a clear with purchase & sale of material into finished goods.
considerable amount of additional work and relationship b/w inputs & costs involving immediate cause & effect goods (in case of  Conversion Cost consists of direct
thus, additional money. outputs. immediate cash relationship b/w inputs & merchandise inventory). wages, direct expenses and
 Requirement of Reconciliation : Results shown by  They usually arise from payment of cash. payment outputs  In production scenario, manufacturing overheads.
cost accounts differ from those shown by periodic decisions  Salaries, wages,  They are  The relationship is usually such costs are associated  So, Conversion Cost = Direct Labour
financial accounts. Thus verification through regarding maximum postage & not personally observable with acquisition & Cost + Direct Expenses +
Reco. is necessary. outlay to be incurred. telegram, printing recorded in  Examples: conversion of materials & Manufacturing Overhead
 Duplication of Work : Involves duplication of  Examples include & stationery, books of Inputs : Direct Material Cost, all other manufacturing  Also, Conversion Cost = Factory Cost –
work as organization has to maintain two sets of advertising, public interest on loan account Direct Labour Costs, etc. inputs into finished Direct Materials Cost
A/Cs viz. Financial A/C and Cost A/C. relations, executive etc. are some  AKA Outputs : Cars, Computers, products for sale
 Inefficiency : Costing system itself does not training etc. examples M‘14 Economic etc. M‘14 N ‘16
control costs but its usage does. costs (2m) (2m)
(2m)

M ‘17
(2m) Cost Unit & its Typical Examples Methods of Costing
Unit of a Product or service or time (or combination of these) in Identify the methods of costing: Nature of Output Method of Costing Cost Eg. of Industries
relation to which costs may be ascertained or expressed. a. Where all costs are directly charged
to a specific job – Job Costing A Series of Processes Process/Operation For each Process Sugar
Industry / Product / Activity Cost Unit Basis b. Where all costs are directly charged
to a group of products – Batch Construction of Building Contract For each Contract Real estate
Automobile Number Costing
c. Where cost is ascertained for a Similar units of a Single Product, Unit or Output or For the entire activity, but averaged
Cement Ton / per bag single product – Unit Costing or Cold Drinks
produced by Single Process Single Costing for the output
Single or Output Costing
Chemicals Litre, kilo, gallon, ton, etc.
d. Where the nature of the product is Rendering of Services Operating Costing For all services Hospitals
Power / Electricity Kilo watt hour (kWh) complex and method can not be
ascertained – Multiple Costing Customer Specifications: Single Unit Job Costing For each order/assignment Advertising
Steel Ton
Multi-varieties of activities/processes Multiple Costing Combination of any method Car Assembly
Transport Passenger-kilometre
M‘18 Users of Cost and Management Accounting
Industry Method of Costing Cost Unit
Gas Cubic feet (5m)
Brewing Barrel Hotel Operation Costing Room day/per Bed Internal Users External Users (Key : RASCAL)
Brick making 1000 Bricks  Managers use information to :  Regulatory Authorities are concerned with cost
Toy Making Batch Costing Units/Batch (i) know the cost of cost object & cost centre accounting data & info. for tariff
Coal mining Tonne/ton (ii) price for product or service determination, providing subsidies, rate
Steel Process Costing Per Tonne/Per MT (iii) Measure performance of resp. centres fixation etc.
Engineering Contract / job (iv) know product & customer-wise profitability
Oil Barrel / tonne / litre (v) evaluate strategic options, make decisions  Shareholders are concerned with info. that
Ship Building Contract Costing Project/Unit effect their investment in entity. Mgmt.
Hotel / Catering Room / meal  Operational Level staff like supervisors, foremen, team communicate shareholders through periodic
Passenger km or leaders require information to know communique, annual reports
Road Transport Operation Costing
Professional Services Chargeable hour, job, contract tonne km (i) Obj. & performance goals for them
(ii) Product & service specifications like volume, quality  Creditors and Lenders are concerned with data
Education Course, Enrolled Student Process Costing / Tonne / Metric & process & info. which affects an entity’s ability to serve
Steel
Single/Unit Costing Ton (MT)/ kg/ bar (iii) Performance parameters against which their lenders or creditors.
Hospital Patient day
performance is measured and evaluated
Credit Control Accounts maintained Number / per (iv) to know divisional (responsibility centre) profitability  Auditors while conducting audit of FS or for
Bicycles Multiple Costing some other special audits like cost audit etc.
piece
Requisitions issued / recd.  Employees are concerned with info. related with time, requires info. related with costing reports
Material Storage
Material movement, value issued Bridge attendance, incentives for work, performance reviewed by mgmt.
Contract Costing Project / Unit standards
construction
Personnel Administration Personnel record

Key : Concept Key: AUNT
SPADES QC Cost Reduction vs Cost Control (is a) PRO
Financial Accounting vs Cost Accounting
Concept Achievement of real & permanent reduction in Cost Control involves a comparison of actual with Analysis of  Shows profit or loss of the organization  Provides cost details for each cost
unit cost of products manufactured the standards or budgets, to regulate the actual Cost and Profit either segment wise or as a whole object i.e. product, process, job,
costs contracts, etc
Savings Realistic savings in cost There could be temporary savings in cost Users of Info.  Shareholders, creditors, financial  Generally used by internal
Performance Not concerned with maintenance of The process involves setting up a target, investing analysts and government and its management, some time regulatory
performance according to standards variances and taking remedial measures to agencies, etc authorities
correct them Nature  It classifies records, present and  It classifies costs, records, present,
Applicability Universally applicable to all areas of business. Limited applicability to those items of cost for interprets transactions in monetary and interprets it in a significant
Does not depend upon standards, though target which standards can be set terms manner
amounts may be set Time Period  FS Prepared usually for a year  Reports and statements prepared
Dynamism Fully dynamic approach Less dynamic than Cost Reduction when required
Emphasis Emphasis here is partly on present costs and Emphasis on present and past behaviour of costs Presentation  Set format for presenting financial  No set formats
largely on future costs of Info. information
Standards Continuous process of critical examination Control is achieved through compliance with Recording of  Records historical data  Makes use of both historical and
includes analysis and challenge of standards standards. Standards by themselves are not Data predetermined cost
examined Objective  Providing info. on financial performance  Ascertainment of cost for cost control
Quality Product’s Utility, Quality and Characteristics are Quality Maintenance is not a guarantee & decision making
retained
Corrective / Cost reduction is a corrective measure Cost Control is a preventive measure
Preventive Marginal Costing vs Absorption Costing
Key: ROAD M’17  Only Variable Costs are considered for  Both Fixed & variable costs are considered for product
(pe) No Divider (4m) Cost Accounting vs Management Accounting
product costing & inventory valuation costing & inventory valuation.
 Fixed costs are regarded as period costs.  Fixed costs are charged to cost of production. Each
Rules and  It follows certain principles and procedures for  It does not follow any specific rules and Profitability of different products is judged by product bears a reasonable share of fixed cost &
Regulations recording costs of different products regulations their P/V ratio. profitability of a product is influenced by
apportionment of fixed costs.
Objective  It records the cost of producing a product and  Provides information to mgmt. for planning and  Cost data presented highlight total  Cost data are presented in conventional pattern. Net
providing a service co-ordination contribution of each product. profit of each product is determined after subtracting
Area  It only deals with cost ascertainment  Wider in scope as it includes financial accounting, fixed cost along with their variable costs.
budgeting, taxation, planning, etc  Difference in magnitude of opening & closing  Difference in magnitude of opening & closing stock
stock does not affect unit cost of production. affects unit cost of production due to impact of related
Development  Development is related to industrial revolution  Develops in accordance with the need of modern fixed cost.
business  In case of marginal costing, cost per unit  In case of absorption costing, cost per unit reduces, as
Nature  Records quantitative aspects only  Records both quantitative and qualitative aspects remains same, irrespective of production as it production increases as it is fixed cost which reduces,
is valued at variable cost. whereas, variable cost remains the same per unit.
Recording of  Uses both past and present figures  Focused on projection of figures for future
Data

Material Cost N‘11
(4m)
Importance of Proper Recording & Material Control Objectives of System of Material control ABC Analysis – System of Inventory Control Advantages – ABC Analysis
(Key : PQRS Wastage) (Key : ROMIO)  A system of inventory control which (Key : [ABC can be learnt easily by an] Attentive Child
 Price of final product: Material constitutes a significant part of any  Reduction in Wastages: Avoidance of unnecessary losses & exercises discriminating control over through Continuous and Systematic Work)
product & cost of final product is directly related with cost of wastages that may arise from deterioration in quality due to different items of stores classified on  Less Attention required : Management time is saved
materials used to produce it. defective or long storage. basis of investment involved. since attention need be paid only to some items
 Quality of final product: Quality of output depends on quality of  Optimisation of Material Cost: Seeing to it that all materials &  Usually, items are divided into 3 rather than all the items.
inputs. stores are acquired at lowest possible price considering quality categories acc. to their importance,  Lower Cost : Cost of placing orders, receiving goods
 Regular information about Resources : Regular & Updated info. on that is required & considering other relevant factors like their value & frequency of replacement & maintaining stocks is minimised specially if
availability & utilisation of materials are necessary for timely reliability in respect of delivery. during a period. system is coupled with determination of proper
& informed decision making.  Minimising interruption in production process: Ensuring that economic order quantities.
 Cost of Stock holding & Stock-out: An entity has to incur stock holding production does not suffer from interruption for want of Category % of items % of inventory  Continuity in production : It ensures that minimum
costs in form of interest and/or opportunity cost for fund used, stock materials & stores. investment will be made in stocks of materials
handling losses like evaporation, obsolescence etc.  Adequate Information: Maintenance of proper records to A 10% 70% without there being any danger of interruption of
 Wastage and other losses: Based on nature of material & process, ensure that reliable info. is available for all items of materials. production due to materials or stores.
these are classified as normal & abnormal for efficient utilisation &  Order Completion in time: Proper material management is very B 20% 20%  Systematic Working : Much of the work connected
control. necessary for fulfilling orders. with purchases can be systematized on a routine
C 70% 10% basis to be handled by subordinate staff.
Bill of Material v/s Material Requisition Note Stock Control Cards M‘18 Just in Time (JIT) Inventory Management
(5m)
 Doc. prepared by engineering  It is prepared by production or  A quantitative record of inventory maintained by stores department  JIT is a system of inventory management with an
Demand for final product
or planning department other consuming department for every item of material. approach to have zero inventory in stores. As
 Recording includes receipt, issue, return, in hand and orders given. per JIT, material should only be purchased when
 A complete schedule  A document authorizing Store- it is actually required for production.
of component parts & keeper to issue materials to Advantages :
Production starts to process
raw materials required for a consuming dept  Records are kept in a more compact manner so that easy reference is  JIT is based on two principles: demand for product
particular job or work order facilitated. (i) Produce goods only when it is required and
 It serves the purpose of  It cannot replace a bill of  Records can be kept in a clean way by men solely engaged in clerical (ii) The products should be delivered to
material requisition as it shows material work so that a division of workers b/w record keeping & actual customers only when they want.
complete schedule of material handling is possible. Material Requirement is sent
materials required for a  As records are at one place, it is possible to get an overall idea of  AKA ‘Demand pull’ or ‘Pull through’ system of to Purchase department
particular job i.e. it can stock position without necessity of going round stores. production.
replace material requisition  In this system, production process actually
Disadvantages : starts after order for products is received.
 It can be used for purpose Order for raw materials sent
 It is useful in arriving historical  On the spot comparison of physical stock of an item with its book  Based on demand, production process starts & to supplier
of quotations
cost only balance is not facilitated. requirement for raw materials is sent to
 It helps in keeping a  It shows material actually  Physical identification of materials in stock may not be as easy as in purchase department for purchase.
quantitative control on drawn from stores case of bin cards, as Stock Control Cards are housed in cabinets or  This can be understood with help of diagram
materials drawn through trays. alongside: Supplier sends material for
material requisition production

Material Cost
M‘18
N‘17
Bin Cards v/s Stores Ledger Advantages & Disadvantages of Bin Cards Classification of Inventories (5m) FIFO Method
(4m)
 Individual/  Each transaction  Transactions may Advantages : On the Basis of Frequency of Usage On the Basis of Criticality  Method of pricing issues
Summarized is individually be summarized &  Fewer mistakes as entries are made as & of materials, in order of
posted. then posted. when goods are received/issued by Fast Moving, Slow Moving & Non Moving (FSN) Vital, Essential & Desirable (VED) Inventory : purchase. Materials are
 Transfers  Inter-department  Material transfer person actually handling materials. Inventory: Under this system, inventories are classified on issued in order of arrival
transfers do not from one job to  Control over stock can be more effective, Classification of items into 3 categories the basis of its criticality for production function or items longest in stock
appear in Bin another job are as comparison of quantity in hand with depends on nature & managerial discretion. & final product. Generally, this classification is are issued first. Each
Card. recorded for book balance is possible anytime. A threshold range on the basis of inventory done for spare parts which are used issue recovers purchase
costing purposes.  Identification of different items of turnover is decided & classified accordingly for production. price which does not
 Entries  Entries are made  It is always materials is facilitated by reference to (i) Fast Moving: These items are placed (i) Vital : Items are classified as vital when its reflect market price.
when transaction posted after the Bin Card, bin or storage vessel. nearer to store issue point & stock is unavailability can interrupt  FIFO is considered
takes place. transaction. reviewed frequently for making of fresh production process & cause a production suitable in falling price as
 (Who)  It is maintained  It is maintained Disadvantages : order. loss. material cost charged to
Maintains by storekeeper in in Cost A/Cing  Store records are dispersed over a wide (ii) Slow Moving: These items are stored (ii) Essential : Items under this category are production will be high
the store. department. area. little far & stock is reviewed periodically essential but not vital. The but replacement cost of
 Contains  It contains only  It contains  Cards smear with dirt & grease due to for any obsolescence which may be then unavailability may cause sub materials will be low.
quantitative information both material handling. shifted to Non-moving category. standardisation & loss of efficiency in  In case of rising prices, if
[Key : ITEM details of material in quantity &  People handling materials are not (iii) Non Moving: These items are kept for production process. FIFO is adopted, charge
Contained (in recd, issued & value. ordinarily suitable for clerical work disposal. These items are reported to (iii) Desirable : Items under this category are to production will be low
Bin Cards and returned to involved in writing Bin Cards. mgmt. & an appropriate provision for optional in nature, unavailability does not compared to
Stores Ledger) ] stores. loss may be created. cause any production or efficiency loss. replacement cost
“Perpetual inventory system comprises Bin Card & Stores Ledger, but efficacy of system Advantages of FIFO Method
M‘13 Continuous Stock Verification  Simple to understand & easy to operate
depends on continuous stock taking.”
(4m)  Material cost charged to production represents
 Perpetual inventory represents system of records maintained by stores dept. It comprises: Bin Cards & Stores Physical Checking of inventory is an essential feature of every sound system actual cost with which cost of production should
Ledger. of material control. The system of continuous stock-taking consists of physical have been charged
 Bin Cards maintain a quantitative record of receipts, issues & closing balances of each item of stores verification of items of inventory. Stock verification may be done without  In case of falling prices, use of FIFO gives better
 Stores Ledger is maintained to record all receipt & issue transactions for materials. It is filled up with help of prior notice by internal audit dept. but are independent of store & production results.
goods received note & material requisitions. staff. The element of surprise is essential for effective control of system.  Closing stock of material will be represented very
 Perpetual Inventory system’s efficacy depends on system of continuous stock taking. Continuous stock taking closely at current market price.
means physical checking of records i.e. Bin cards & stores ledger with actual physical stock. Advantages: Disadvantages of FIFO Method
Main advantages of perpetual inventory are as follows : (Key : PQRS + Discrepancies) 1. Closure of normal functioning is not necessary.  If prices fluctuate frequently, FIFO may lead to
(1) Physical stocks can be counted & book balances adjusted when required w/o waiting for entire stock-taking. 2. Stock discrepancies are likely to be brought to notice & corrected much clerical error.
(2) Quick compilation of P&L A/c due to prompt availability of stock figures. earlier than under annual stock-taking system.  Since each issue of material is related to a
(3) Systematic Review of perpetual inventory reveals existence of surplus, dormant, obsolete & slow-moving 3. System generally has a sobering influence on stores staff because of specific purchase price, costs charged to same job
materials for further remedial measures. surprise element. are likely to show a variation between periods
(4) Fixation of various Stock Levels & checking of actual balances in hand with these levels assist Store keeper in 4. Movement of stores items can be watched more closely by stores  In case of rising prices, real profits of concern
maintaining stocks within limits & in initiating purchase requisitions for correct quantity at proper time. auditor. being low, may not be adequate to meet
(5) Discrepancies are easily located & corrective action can be promptly taken. 5. Final Accounts can be ready quickly. Interim accounts are possible quite materials purchase demand at market price.
conveniently.

Material Cost
Waste Scrap Spoilage Defectives Obsolescence
Concept  The portion of  Materials which are discarded &  It is the term used for materials which are badly  It signifies those units or portions of production Obsolescence is defined as “the loss in the intrinsic
raw material disposed-off without damaged in manufacturing operations, and they which do not meet quality stds. They arise due to value of an asset due to its supersession”.
which is lost further treatment. cannot be rectified economically & hence sub-standard materials, bad supervision, bad Materials may become obsolete under any of the
during storage  Generally, scrap has either no value taken out of process to be disposed of in some planning, etc. following circumstances:
or production or insignificant value. Some time it manner without further processing.  Defectives which can be re-made as per quality std. (i) Where it is a spare part or component of m/c
and discarded. may be reintroduced into the by using additional materials are known as reworks. used in mfg. & that m/c becomes obsolete;
 Defectives which cannot be brought up to quality (ii) where it is used in mfg. of product which has
The waste may process as raw material.
standards are known as rejects which may either be become obsolete;
or may not have
disposed- off or re-cycled for production process. (iii) where material is replaced by another mat.
any value. due to improved quality or fall in price
Treatment-  Cost of normal  The cost of scrap is borne by good  Normal spoilage costs are included in costs  The cost less realisable value on sale of defectives  In all 3 cases, value of obsolete material held in
Normal waste is units and income arising on account either by charging it to production order or to are charged to material cost of good production. stock is total loss & immediate steps should be
absorbed by of realisable value is deducted from production overhead. Salvage realised is taken to dispose it off at best available price.
good production cost. credited to production order or
units. production overhead account.
Treatment-  Cost of  Scrap account should be charged  The cost of abnormal spoilage is charged to  Material Cost of abnormal defectives are not  The loss arising out of obsolete materials on
Abnormal abnormal loss is with full cost. Credit is given to job Costing P&L A/c. When spoiled work is result of abnormal loss does not form part of cost of mfg.
included in material cost but treated as loss after
trfd. to Costing or process concerned. Profit or loss rigid specification, cost of spoiled work is
giving credit to the realisable value of such
P&L A/c. in scrap account, on realisation, absorbed by good production while cost of
will be trfd. to Costing P&L A/c. disposal is charged to production overhead. defectives. Material cost of abnormal loss is
transferred to Costing P&L A/c.
M‘18
Waste vs Scrap N‘15 Scrap vs Defectives Reclamation of loss from defective units LIFO Method
(5m)
(2m)
 It is connected  It is connected with  It is loss connected with  This type of loss connected In case of articles that have been spoiled, it is necessary to  It is a method of pricing the issues of materials on the
with raw material output output with the output but it can take steps to reclaim as much of loss as possible. For this : assumption that the items of the last batch (lot) purchased are
or inputs to be in the input as well. (i) All defective units should be sent to place fixed for the first to be issued.
production  Scraps are not intended  Defectives also are not purpose;  The prices of the last batch (lot) are used for pricing the issue,
process. but cannot be eliminated intended but can be (ii) These should be dismantled; until it Is exhausted, and so on.
 Waste of  Scraps are generally due to nature of material eliminated through proper (iii) Goods & serviceable parts should be separated &  Cost of Materials Issued represents the cost of latest purchases.
materials may be identifiable and has or process itself. control. taken into stock; Cost of Closing Stock represents the cost of earlier purchases.
visible or invisible. physical substance.  Generally scraps are not  Defectives can be used (iv) Parts which can be made serviceable by further work  During inflationary period, the use of LIFO would help to ensure
 Generally waste  Scraps are termed used or rectified. after rectification. should be separated & sent to workshop for the that the cost of production determined on the above basis is
has no as by-products &  Scraps have insignificant  Defectives are sold at lower purpose & taken into stock after defects have been approximately the current one.
recoverable value. has small recoverable value. value from that of good removed;
recoverable value. one. (v) Parts which cannot be made serviceable should be
collected in one place for being melted or sold.

Employee Cost & Direct Expenses
Requisites of a Good Time Keeping System Normal Idle Time Abnormal Idle Time
1. System should not allow proxy for another employee. Causes Treatment Causes Treatment
2. A provision of recording of time of piece employees so that regular  Time lost between  Treated as part of cost of  Idle time may also arise due to abnormal  Abnormal idle time cost is not included as a
attendance and discipline may be maintained. factory gate & place of production. In case of direct factors like lack of coordination, Power failure, part of production cost & is shown as a
3. Time of arrival & time of departure of employees should be work. workers, allowance for normal Breakdown of machines, Non-availability of separate item in Costing P&L A/c.
recorded for wages calculation. idle time is considered setting raw materials, strikes, lockouts, poor  Cost of abnormal idle time should be further
4. Method of recording of time should be mechanical so that disputes of std hours or std. rate. supervision, fire, flood etc. categorised into controllable & uncontrollable.
regarding time may not arise between employees & time-keeper.  The interval between  In case of indirect workers,  Causes for abnormal idle time should be For each category, break-up of cost due to
5. Late-comers should record late arrivals. Any relaxation by time- one job & another normal idle time is considered further analysed into controllable & various factors should be separately shown.
keeper in this regard will encourage indiscipline. for computation of overhead uncontrollable. This would help mgmt. in fixing responsibility
6. System should be simple, smooth and quick. Unnecessary queuing rate. 1. Controllable abnormal idle time refers to that for controlling idle time.
for marking attendance should be avoided.  Setup time for machine time which could have been put to productive 1. Management should aim at eliminating
7. System should be reviewed & maintained periodically to prevent  Normal rest time, use had the mgmt. been more alert & controllable idle time & on a long-term basis
any error. break for lunch efficient. reducing even normal idle time. This would
2. Uncontrollable abnormal idle time refers to require a detailed analysis of causes leading
Overtime Premium time lost due to abnormal causes, over which to such idle time.
management does not have any control e.g.,
Causes Treatment breakdown of machines, flood etc.
 Customer may agree to bear entire charge of OT because  If OT is resorted to at desire of customer, premium may be
urgency of work. charged to job directly.
 OT may be called for to make up any shortfall in production due  If OT is required to cope with general production programmes or Halsey Premium Plan
to some unexpected development. for meeting urgent orders, premium should be treated as
overhead cost of particular dept. / cost centre which works OT. Advantages Disadvantages
 Time rate is guaranteed while there is opportunity  Incentive is not so strong as with piece rate
 OT work may be necessary to make up a shortfall in production  If OT is worked in a dept. due to fault of another dept., premium for increasing earnings by increasing production. system. The harder the worker works,
due to some fault of management. should be charged to latter department.  The system is equitable in as much as employer gets lesser he gets per piece.
a direct return for his efforts in improving  The sharing principle may not be liked by
 OT may be resorted to, to secure out-turn in excess of normal  OT worked on account of abnormal conditions such as flood, production methods and providing better employees.
output to take advantage of expanding market or rising demand earthquake etc., should be charged to Costing P&L A/c. equipment.
Time Rate System Rowan Premium Plan

Merits Demerits Advantages Disadvantages
1. Simple to understand and to calculate wages. 1. No monetary incentive to raise the level of production.  Claimed to be a fool-proof system in as much as a worker  System is a bit complicated.
2. Reduces temptation on the part of workers to increase the 2. No distinction between the slow and the efficient worker. can never double his earnings even if there is bad rate  Incentive is weak at a high production
output at the cost of quality. 3. The tendency is for the fall in output; this raises cost per unit. setting. level where time saved is more than
3. Unity in employee, no distinction between efficient and 4. A firm cannot be sure of employee costs per unit under this method  Admirably suitable for encouraging moderately efficient 50% of time allowed.
inefficient employee due to quality of production. and, hence, may suffer a loss on quotations if already submitted. workers as it provides a better return for moderate  Sharing Principle not
4. Stability in wages efficiency than under Halsey Plan. generally welcomed by employees.
 Sharing principle appeals to employer as being equitable.

Employee Cost & Direct Expenses
M‘11
Factors increasing Employee productivity Employee Turnover Methods of Calculating Employee Turnover (4m) Causes of Employee (Labour) Turnover
N’10,
1. Employing only workers with right type of Employee turnover Replacement Method: N’14 (4m) Personal Causes: Unavoidable Causes : Avoidable Causes :
skill. or labour turnover Number of employees Replaced during the period  Change of jobs for  Seasonal nature of business  Dissatisfaction with job,
x100
2. Right Man for the right job in an organisation is Average number of employees on roll betterment  Shortage of raw material, remuneration, hours of work,
3. Train young & old workers by providing the rate of change in  Premature retirement power, slack market for the working conditions
them right types of opportunities composition of Separation Method : due to ill health or old product etc.  Strained relationship with mgmt,
4. Taking appropriate measures to avoid employee force Number of employees Separated during the period age  Change in the plant location supervisors, fellow workers
x100
situation of excess or shortage of during a specified Average number of employees on roll  Domestic problems and  Disability, making a worker  Lack of training facilities &
employees period measured family responsibilities unfit for work promotional avenues,
5. Carrying out work study for fixation of against a suitable Flux Method :  Discontent over the  Disciplinary measures recreational medical facilities
wages & for simplification & standardisation index Number of employees Separated + Replaced jobs and working  Marriage (generally in the case  Low wages and allowances.
of work x100 environment of women)
Average number of employees on roll
M’10,M’12
M’15 (4m)
Cost Accounting System
N’09
Integrated Accounting System & its advantages Motivational Factors for Adopting a Reconciliation Process (2m) Items included in Financial Accounts only Cost Accounts only
System of A/cing where both costing & financial transactions  When cost & financial accounts are kept separately, it is Purely Financial Expenses Purely Financial Notional Expenses
are recorded in same set of books. imperative that these should be reconciled, otherwise cost  Interest on loans or bank mortgages Income  Charges in lieu of rent where
Advantages accounts would not be reliable.  Expenses relating to issue & trf. of share & deb.  Interest recd. premises are owned
 No need for Reconciliation - The question of reconciling  Reco. of two set of accounts can be made, if both sets contain viz. stamp duty expenses; discount on share & on bank  Interest on cap (though not
costing profit & financial profit does not arise, as there is sufficient detail to enable causes of differences to be located. debentures etc. deposits, loans incurred)
only one figure of profit.  In financial accounts, expenses should be analysed in same  Losses on sales of fixed assets & investments & invst.  Salary for proprietor (though
 Less efforts - Due to use of one set of books, there is way as in cost accounts.  Fines and penalties  Dividends recd not incurred)
N’17
significant saving in efforts made. Motivation for reconciliation is :  Damages payable under law  Profits on sale  Notional dep. on fully dep
(4m)
 Less time consuming - No delay is caused in obtaining  To ensure reliability of cost data.  Legal charges of FA & invst. asset (BV = Nil)
information provided in books of original entry.  To ensure ascertainment of correct product cost.  Goodwill, Preliminary Expenses written off  Transfer fee  Items whose treatment is diff
 Economical Process - It is economical also as it is based on  To ensure correct decision making by the management based  Income tax, Donations, Subscriptions recd in two sets of account
the concept of ‘Centralization of Accounting Function’. on Cost & Financial data.  Expenses of Company’s share transfer office  Rent receivable  Varying basis of valuation
M’13
(4m)
Is reconciliation of cost & financial accounts necessary in case of integrated accounting system?
 In integrated accounting system, cost and financial accounts are kept in the same set of books.
 Such a system will have to afford full information required for Costing as well as for Financial Accounts.
 In other words, information and data should be recorded such a way so as to enable firm to ascertain cost of each product, job, process, operation or any other identifiable activity.
 It also ensures ascertainment of marginal cost, variances, abnormal losses & gains.
 In fact, all information that management requires from system of Costing for doing its work properly is made available.
 Integrated accounts give full information in a manner that P&L A/c & Balance sheet can be prepared according to requirements of law & mgmt. maintains full control over liabilities & assets of business.
 Since, only one set of books are kept for both cost accounting and financial accounting purpose so there is no necessity of reconciliation of cost and financial accounts

Overheads
M’10,
N’10 ’14 ’15 M‘13
(4m) Treatment of Over and Under Absorption in Cost Accounting (4m)
Cost Allocation v/s Cost Absorption
Over/Under Amount of under-absorbed or over-absorbed overheads is trfd. (credited or debited) to  Meaning  Cost allocation is the allotment of  Cost absorption is the process of absorbing all
Transfer to
Absorption Costing P&L Account when whole item of cost to a cost centre or a indirect costs or overhead costs allocated or
Costing
Under-  amount is minor and insignificant or cost unit apportioned over particular cost centre or
P&L A/c
absorption has  it is caused by abnormal circumstances i.e., the factors beyond control of mgmt production department by the units produced.
effect of  Sequence  Allocation of overheads occurs before  Absorption of overheads is the last step in the entire
understating Amount is carried over to subsequent years when over absorption in current period will absorption in the process of process of distribution of overheads and result in an
cost while be neutralized by under-absorption in the next. This method may be followed when: distribution of overheads ultimate charge to products, jobs or orders etc
Carry
over-  industry is seasonal with fluctuation in demand & production
Forward
absorption has  normal business cycle extends >1 year M‘14 Cost Allocation v/s Cost Apportionment
to next year
effect of  project is new & output is initially low but there will be more output in next year (4m)
overstating which will absorb more overheads.  Meaning  Allocation is a direct process of charging  Apportionment is an indirect process because
cost. Over or expenses to different cost centres there is a need for the identification of the
under- When Amount is significant or large, then cost of product needs to be adjusted by using appropriate portion of an expense to be borne by
absorption of Supplem- supplementary rates. It is calculated by dividing amount of over absorption or under- the different departments benefited.
overheads may entary Rate absorption by equivalent units usually. Under this method, balance of under & over  Deals with  Deals with whole items of cost, which are  Deals with proportions of an item of cost.
be disposed of Method absorbed overheads may be charged to cost of W.I.P., finished stock & cost of sales identifiable with any 1 department.
in foll. ways: proportionately with help of supplementary rate of overhead.  Nature of  Possible when nature of expenses is such  Done in case of those overhead items which can’t
Expense that it can be easily identified with a be allocated to a particular department.
As Prime Cost of primary packing necessary for protecting product or for convenient handling - particular cost centre
H M‘11 Cost Prime Cost.  Example  Salary paid to foreman of particular  Salary paid to works manager of factory cannot be
O (4m)
production dept. can be directly identified charged wholly to particular production dept. but
W As Distrib- Cost of packing to facilitate transportation of product from factory to customer - with that dept. & it will be directly will have to be charged to all departments of
1. ution Cost Distribution Cost. charged to that department. factory on equitable basis.
T Packing  Basis for  No basis is required for allocation.  Apportionment is made on some basis which may
Expenses On Specific If cost of special packing is at request of customer - Specific Work Order or Job. Distribution be area, assets value, number of workers etc.
O
Job
 It is that part of capacity of a plant, machine or equipment which cannot be effectively utilised in production.
D As Selling Cost of fancy packing necessary to attract customers is an advertising expenditure. N‘15  It may arise due to lack of product demand, no availability of raw-material, shortage of skilled labour, shortage
E Overhead Hence - selling overhead. (4m) of power, etc.
A 3.  Costs associated with idle capacity are mostly fixed in nature. These costs remain unabsorbed or unrecovered
 These are additional payments/facilities provided to workers apart from their salary and allowances due to under-utilisation of plant and service capacity.
L like house rent, dearness allowances, etc. These are given in form of OT, extra shift duty allowance, Idle
Capa Treatment
holiday pay, pension facilities, etc.  If idle capacity cost is due to unavoidable reasons, a supplementary overhead rate may be used to recover idle
2. city
W  Such indirect benefits tend to improve morale, loyalty & stability towards organization. capacity cost. In this case, costs are charged to production capacity utilised.
Fringe Costs
I  Expenditure on fringe benefits in respect of factory workers should be apportioned among all  If idle capacity cost is due to avoidable reasons such as faulty planning, etc. cost should be charged to Costing
Benefits
production & service depts. on basis of no. of workers in each dept. Profit & Loss Account.
T M‘11  If amount of fringe benefit is considerably large, it’ll be recovered as direct charge by a  If idle capacity cost is due to trade depression, etc., - being abnormal in nature, cost should also be charged to
H (4m) supplementary wage rate otherwise collected as part of production overheads. Costing Profit & Loss Account.

Activity Based Costing, Activity Based Budgeting and Activity Based Cost Management
ABC ABB Value Added Activities Non Value Added Activities Categories in ABC
 An accounting methodology  Activity Based Budgeting  An activity that customers perceive as  An activity where there is an opportunity  Unit Level Activities :
 Assigns costs to activities is a process of planning & adding usefulness to product or service they of cost reduction without reducing the - Use of indirect materials, Inspection / Testing, Indirect Consumables
rather than products & controlling expected purchase. product’s service potential to customer.  Product Level Activities :
services. Enables resources & activities for organisation  An activity that, if eliminated, will  Activity that, if eliminated, will NOT - Product Design, Customized Production of Parts, Advertising Costs
overhead costs to be to derive a cost-effective reduce actual utility which customers obtain reduce actual or perceived value that  Facility Level Activities :
accurately assigned budget that meets from using product or service. customers obtain by using product or - Maintenance of Buildings, Plant Security
to products & services that forecasted workload &  Enhance value of products & services in eyes service.  Batch Level Activities :
consume them agreed strategic goals. of organisation’s customers while meeting  Do not contribute to customer-perceived The cost of some activities is driven by the number of batches of units
 Resources are assigned to  Key Elements (TQC) its own goals. value produced. Examples of this are:
activities & activities are - Type of activity  Example:  Example: - Material Ordering – An order is placed for every batch of production.
assigned to cost objects based - Quantity of activity - Painting a car in a company manufacturing - Storage & moving of raw materials, - Machine Set-up Costs – M/c need reset b/w different production batch
on consumption estimate - Cost of activity cars; or reworking or repairing of products - Inspection of Products – 1sti item in every batch is inspected rather
- A computer manufacturing company making than every 100th item
computers with preloaded software.
Business Applications of ABM ABC : A Decision Making Tool Activity Based Costing vs Traditional Absorption Costing
Key : CAR ka Driver CAR mein hai
(Key: ABC uses Benchmarking for Performance (Key: Wholesalers TAP Market for Facilities and Human Resources)
Measurement) Classification Activities are classified as – Activities are classified as –
 Activity Based Budgeting : SAME AS ABOVE  WHOLESALE DISTRIBUTORS can gain significant advantage in (i) Unit Level, (ii) Batch Level, (iii) Product Level (i) Unit Level (Variable) and (ii) Facility Level (Fixed)
 Business Process Re-Engineering : decision-making process through implementation of ABC and (iv) Facility Level activities activities
Involves examining business processes & making concepts.
substantial changes in day to day operation of  ABC is a complement to TQM. Allocation Overheads are related to activities and Overheads are related to cost centers /
organisation.  Using Traditional ABSORPTION costing, overheads may get grouped into activity cost pools departments
 Cost Reduction : distributed equally across all product lines. ABC traces costs back
ABCM helps in identification of costs against to activity and consumption of resources by each product. Realistic / Costs are related to activities and hence are Costs are related to cost centers and hence not
activities & to find opportunities to achieve reduction  Companies who wish to determine PRICE based on cost plus Non Realistic more realistic realistic of cost behaviour
in unit cost of products manufactured. It continuously mark-up basis find ABC method of costing very relevant to
attempts to achieve genuine savings in cost determine competitive prices. Driver Activity–wise cost drivers are determined Time (Hours) are assumed to be the only cost
 Benchmarking :  Other areas where ABC system can be relevant include MARKET, driver
Benchmarking is process of identifying & learning MAKE OR BUY decisions, TRANSFER PRICING, SHUT DOWN Cost Control ABC aids cost control Not suitable for cost control
from best practices. It is a powerful tool for decisions, etc.
continuous improvement.  Other decisions that can be assisted by ABC include FACILITY and Assigned to Cost are assigned to cost objects, e.g. Costs are assigned to Cost Units i.e. to products,
 Performance Measurement : resource expansion. Often, the basis for relocation or opening of customers, products, services, departments or jobs or hours
Organizations are now focussing on activity a new distribution centre is based on cost associations.
performance as a means of facing competitors &  Decision support for HUMAN RESOURCES can be augmented by Recovery Activity–wise recovery rates are determined Either multiple overhead recovery rate (for each
managing costs by monitoring the effectiveness & ABC. Where activity & cost can be associated to an individual, Rate & there is no concept of a single overhead department) OR a single overhead recovery rate
efficiency of activities new levels of financial performance can be determined. recovery rate may be determined for absorbing overheads

Unit Costing, Batch Costing & Job Costing
M’18 N’16
Unit Costing (5m) Batch Costing (4m) Job Costing Job Costing v/s Batch Costing
 A method of costing used where output  A form of specific order costing where articles are manufactured in  Method of costing used when work is undertaken  Method of costing used for  Homogeneous products
produced by an entity is identical & each predetermined lots, known as batch. as per customer’s special requirement. non-standard & non- produced in a continuous
unit of output require identical cost.  Cost object for cost determination is a batch for production rather  When an inquiry is received from customer, costs repetitive products produced production flow in lots
 AKA Single or Output Costing but these than output as seen in unit costing. expected to be incurred on job are estimated & as per customer specification  Cost determined in
are sub-divisions of unit costing method.  Each batch consists of a number of like units. Each batch is treated as on basis of this estimate, a price is quoted to against specific orders. aggregate for the entire
 Followed by industries which produce a cost unit. All costs are accumulated & ascertained for each batch. customer.  Cost determined for each Job Batch and then arrived at
single output or few variants of a single  A separate Batch Cost Sheet is used for each batch and is assigned a  Actual cost of materials, labour & overheads are  Jobs are different from each on per unit basis.
output. certain number by which the batch is identified. accumulated & on completion of job, these actual other and independent of  Products produced in a
Cost per unit = Total Cost of Production Cost per unit = Total Cost of batch costs are compared with quoted price & profit or each other. Each Job is batch are homogeneous
No. of Units produced No. of items produced loss is determined. unique and lack of individuality
Job Costing - Advantages and Disadvantages Job costing v/s Process Costing
Joint Products &
Advantages
 Details of Cost of material,
Disadvantages
 Job Costing is costly and
 A Job is carried out or a product is produced by specific
orders
 The process of producing the product has a continuous flow
and the product produced is homogeneous
By Products
labour & overhead for all job is laborious method  Costs are determined for each job  Costs are compiled on time basis i.e., for production of a given
available to control  As lot of clerical process accounting period for each process or department Methods of Apportionment of
 Profitability of each job can be is involved, chance of  Each job is separate and independent of other jobs  Products lose their individual identity as they are manufactured Joint Costs amongst Joint Products
derived error is more in a continuous flow
 It facilitates production planning  Not suitable  Each job or order has a number and costs are collected  The unit cost of process is an average cost for the period 1. Market value after further processing :
 Budgetary control & in inflationary condition against the same job number  Basis of apportionment of joint cost is
Standard Costing can be applied  Previous records of costs  Costs are computed when a job is completed. The cost of a  Costs are calculated @ end of cost period. Unit cost of process total sales value of finished products
in job costing will be meaningless if job may be determined by adding all costs against the job may be computed by dividing total cost by output of process
 Spoilage & detective can there is any change  As production is not continuous & each job may be different,  Process of production is usually standardized and is therefore, 2. Average Unit Cost Method :
be identified & responsibilities in market condition managerial attention is reqd. for effective control quite stable. Control is comparatively easier  Average unit cost = Total process cost
can be fixed accordingly (upto point of separation) ÷ Total
units of joint product produced.
3. Physical Unit Method : 4. Net Realisable Value at Split-off Point : 5. Market value at point of separation :  6. Contribution Margin Method :
 Based on assumption that joint products are capable of being  NRV of each joint product is found out  Used for apportionment of joint costs to joint products  Joint costs are segregated into 2 parts-variable & fixed.
measured in same units. Accordingly, joint costs are apportioned on & Joint Costs are apportioned in ratio upto split off point. It is difficult to apply this method if MV  Variable costs are apportioned over joint products on basis
the basis of some physical base, viz. weight, numbers. of such NRV. of products at point of separation is not available. of units produced (average method). In case products are
 Basis used for apportioning joint cost over joint products is physical  NRV is found out by deducting foll.  To determine apportionment of joint costs over joint further processed after point of separation, all variable cost
volume of material present in joint products at point of separation. from sales value of joint products (at products, a factor known as multiplying factor is incurred be added to variable costs determined earlier.
Any loss arises during joint production process is also apportioned over finished stage i.e. after further determined.  Thus, total variable cost is arrived which is deducted from
products on same basis. processing): their respective sales values to ascertain their contribution.
 This method cannot be applied if physical units of two joint products • estimated profit margins Multiplying factor : Joint Cost X 100  Fixed costs are then apportioned over joint products on the
are different. Main defect of this method is that it gives equal • selling and distribution expenses, and Total Sales Revenue basis of contribution ratios.
importance and value to all joint products. • post-split off costs N’10
(4m)

Contract Costing
N‘13
N‘14 M’15
Cost Plus Contracts & its Advantages Process of estimating profit / loss on incomplete contracts Notional Profit (4m) Retention Money (2m) Escalation Clause
 Contract Price is ascertained by adding a  <25% complete : No profit should be taken into account  Is the balancing figure  Contractor does not receive full  This clause is usually provided in
percentage of profit to total cost of work.  25% or more but : 1/3 × Notional Profit × Cash Received of contract account payment of work certified by Surveyor. contracts as a safeguard against any
 Such types of contracts are entered into when it <50% complete Work certified prepared by contractor  Contractee retains some amount (say likely changes in price or utilization of
is not possible to estimate contract cost with  50% or more but : 2/3 × Notional Profit × Cash Received if the total of credit 10% to 20%) to be paid, after material & labour.
reasonable accuracy due to unstable condition <90% complete Work certified side exceeds the total sometime, when it is ensured that  If during execution of contract, prices
of material, labour, services, etc.  Contract nearing : Est. Profit × Work Certified of debit side. there is no fault in work carried out by of materials/labour rise beyond
Advantages completion, i.e. Contract price  Represents the diff. b/w contractor. certain limit, contract price will be
 Contractor is assured of fixed percentage of b/w 90% and 100% Est. Profit × Cash Received value of work certified  Any deficiency or defect noticed in increased by agreed amount.
profit. There is no risk of incurring any loss on complete Contract price & cost of work certified. work, is to be rectified by contractor  Such Escalation Clause usually relates
contract. Est. Profit × Cost of work to date  It is determined as before release of retention money. to change in price of inputs, it may
 It is useful specially when work to be done is not M’11 Estimated total cost follows:  Retention money provides a safeguard also be extended to increased
definitely fixed at the time of making estimate. M’17 Est. Profit × Cost of work to date x Cash Recd. Notional profit = Value of against risk of loss due to faulty consumption/ utilization of quantities
 Contractee can ensure himself about ‘cost of (4m) Est. total cost Work Cert. work certified – (Cost of workmanship. of materials, labour etc.
contract’ as he is empowered to examine books Notional Profit × Work Certified work to date – Cost of work  It is determined as follows :  Contractor has to satisfy contractee
& documents of contractor to ascertain veracity Contract price not yet certified) Retention Money = Value of work certified that increased utilization is not due
of cost of contract. – Payment actually made/ cash paid to his inefficiency.
Progress Payment
N’12
(4m)
N’13
(4m)
Process Costing
 It refers to amount received by
contractor from contractee for a Inter Process Profit - Advantages & Disadvantages Equivalent Production OperaTION Costing (Don’t Confuse with OperaTING Costing)
particular period.
 In some process industries, output of one process is  When opening & closing stocks of work-in-process  This product costing system is used when an entity produces more than one
Computation transferred to next process not at cost but at market exist, unit costs cannot be computed by simply variant of final product using different materials but with similar conversion
Value of Work Certified – Retention value or cost plus a percentage of profit. dividing total cost by total number of units still in activities. Which means conversion activities are similar for all product variants but
money – Payment to date  Difference b/w cost & transfer price is known as inter- process. materials differ significantly.
process profits.  We can convert work-in-process units into finished  Operation Costing method is AKA Hybrid product costing system as material costs are
Cash Received Vs. Progress Payment Advantages units called equivalent production units so that unit accumulated by job order or batch wise but conversion costs i.e. labour & overhead
 Total amount received by  Comparison between cost of output & its market price at cost of these uncompleted (W-I-P) units can be costs are accumulated by department & process costing methods are used to assign
contractor on a particular date is stage of completion is facilitated. obtained. these costs to products. Under operation costing, conversion costs are applied to
referred to as Cash received  Each process is made to stand by itself as to profitability.  Equivalent Production units = Actual number of units products using predetermined application rate based on budgeted conversion costs.
whereas the amount received by in production × Percentage of work completed  Eg. A company is manufacturing two grades of products, Product - Deluxe & Product-
contractor from contractee for a Disadvantages  It consists of - Regular. Both products pass through similar production process but require different
particular period is called  Use of inter-process profits involves complication.  balance of work done on opening work-in-process quality & quantities of raw materials. Cost of raw material is accumulated on basis of
Retention money.  System shows profits which are not realised because of  current production done fully and job or batches or units of two variants of products. But, costs for conversion
 Thus, Cash received is for all the stock not sold out.  part of work done on closing WIP with regard to activities need not be identified with product variants as both Products requires
collective periods whereas different elements of costs viz., material, labour similar activities for conversion. Hence, conversion activity costs are accumulated on
retention money is not. and overhead. basis of departments or processes only.

Standard Costing
Steps involved in adopting standard costing system Advantages of Standard Costing Criticism of Standard Costing
 Setting of Standards : 1st step is to set standards which are to be  It serves as a basis for MEASURING OPERATING PERFORMANCE & COST CONTROL. By  Variation in price : One of the chief problem faced in operation of standard
achieved. setting standards, proper classification and determination of variances is possible. costing system is precise estimation of likely prices or rate to be paid.
 Ascertainment of actual costs : Actual cost for each component of cost is  It aids PRICE FIXING. Standard costing can be used to predict costs. The variability of prices is so great that even actual prices are not
ascertained from books of account, material invoices, wage sheet, charge  Introduction of standard costing facilitates EVALUATION OF JOBS & INTRODUCTION necessarily adequately representative of cost.
slip. OF INCENTIVES.  Varying levels of output : If standard level of output set for pre-
 Comparison of actual cost & standard cost : Actual costs are compared  Standard costing facilitates the ESTIMATION OF COST OF NEW PRODUCTS with determination of standard costs is not achieved, standard costs are said to
with the standards costs and variances are determined. greater accuracy. be not realised.
 Investigation of variances : Variances arising are investigated for further  It serves as a basis for INVENTORY VALUATION.  Changing standard of technology : Not suitable for industries having
action. Based on this, performance is evaluated and appropriate actions  Standard costing greatly aids BUSINESS PLANNING, BUDGETING & MANAGERIAL frequent technological changes affecting production.
are taken. DECISION MAKING.  Attitude of technical people : Technical people are accustomed to think of
 Disposition of variances : Variances arising are disposed off by transferring  Standard costing aids in STANDARDISATION OF PRODUCTS, OPERATIONS & standards as physical standards and therefore, they will be misled by
to relevant accounts (costing P&L A/c) as per accounting method (plan) PROCESSES. standard costs.
adopted  Fixation of standards may be costly : May require higher skill & competency.
M’12 M’12
Marginal Costing N’13 N’13
(2m) (4m) (4m) (4m)
Key Factor Angle of Incidence Marginal Costing CVP Analysis - Basic assumptions Practical Application of Marginal Costing Margin of Safety & Relationship b/w Op. Leverage & MOS Ratio
 A factor which  This angle is formed  Costing System  Changes in levels of revenues &  Pricing Policy : Since marginal cost per unit  Margin of Safety (MoS) is the EXCESS OF TOTAL SALES OVER THE BREAK
at a particular by intersection of where products and costs arise only because of is constant from period to period, firm EVEN SALES. MoS defines the amount upto which level sales can decline
time or over a sales line & total cost services are valued at changes in number of products (or decisions on pricing policy can be taken before occurring loss. A greater MoS reflects soundness of business. If
period limits line at break-even variable costs only. It service) units produced & sold. particularly in short term. MoS is small, any fall in sales value may even result in loss.
activities of an point. does not take  Total cost can be separated into 2  Decision Making : MC helps mgmt. in taking
undertaking.  This angle shows rate consideration of fixed components - Fixed & variable. business decisions like make or buy, Margin of safety = Actual sales or output – Break even sales or productions
 It may be the at which profits are costs.  Graphically, behaviour of total discontinuance of a particular product, Margin of Safety Ratio = Sales – Break Even Sales
level of being earned once  This system of revenues & total cost are linear in machine replacement, etc. Sales
demand for break-even point has costing is AKA direct relation to output level within a  Ascertaining Realistic Profit : Stock of Relationship between Operating Leverage and Margin of Safety
products or been reached. costing as only direct relevant range. finished goods & WIP are carried on  Op. leverage is calculated as Contribution ÷ Operating profit wherein
service or it  Wider the angle, the costs forms part of  Selling price, variable cost per unit marginal cost basis & fixed exp. are written contribution margin plays an important role.
may be greater is rate of product costs. & total fixed costs are known & off to P&L A/c as period cost.  If sales are expected to increase, higher operating leverage will result in
shortage of earning profits.  Costs are classified constant.  Determination of production level : MC higher profit. When sales are expected to decrease, lower operating
one or more  A large angle of on the basis of  All revenues & costs can be added, helps in preparation of break-even analysis leverage will result in higher profit.
of productive incidence with a high behaviour rather than subtracted & compared without which shows effect of increasing or  Higher variable cost & lower fixed cost will result into higher MoS & risk
resources. margin of safety functions as done in taking into account time value of decreasing production activity on will be lower & vice versa.
M’10 indicates extremely absorption costing. money. profitability.  So, like Operating leverage, MoS is a measure of risk as to what extent an
(2m) favourable position. organisation is exposed to change in sales volume.

Budget & Budgetary Control
Important Formulae Zero Based Budgeting
1. Efficiency Ratio (Standard Hours / Actual Hours) × 100 Advantage of ZBB Limitations of ZBB (Key : OT₃)
2. Activity Ratio (Standard Hours / Budgeted Hours) × 100 1. Provides a systematic approach for evaluation of different 1. Various OPERATIONAL PROBLEMS are likely to be faced in implementing the technique.
3. Calendar Ratio (Avail. Working Days / Budg. Working Days) × 100 activities & ranks them in order of preference for 2. The full SUPPORT of TOP MANAGEMENT is required.
4. Standard Capacity Usage (Budgeted Hours / Max. Possible Hours in allocation of scarce resource. 3. It is TIME CONSUMING as well as COSTLY.
Ratio Budgeted Period) × 100 2. Ensures that various functions of organisation are critical 4. It requires proper TRAINED MANAGERIAL STAFF
5. Actual Capacity Usage (Actual Hours Worked / Maximum for achievement of its objectives & are being performed
Ratio Possible Working Hours in a Period) × 100 in best way. Steps involved in the process of Zero Based Budgeting (Key : DEAD Body)
6. Actual Usage of (Actual Working Hours / Budgeted Hours) × 100 3. Provides an opportunity to mgmt. to allocate resources 1. DETERMINATION of a SET OF OBJECTS is the pre-requisite and essential step in the direction of
Budgeted Capacity Ratio for various activities after having a thorough cost-benefit ZBB technique.
analysis. 2. Deciding about the EXTENT to which the technique of ZBB is to be applied whether in all areas
M‘14
Budget Manual 4. Area of wasteful expenditure can be easily identified & of organization activities or only in few selected areas on trial basis.
(4m)
eliminated. 3. Identify the AREAS where decisions are required to be taken.
Collection of documents that contains key information. Typical contents : 5. Departmental budgets are closely linked with corporate 4. Developing DECISION PACKAGES and ranking them in order of performance.
 Introductory explanation of budgetary planning & control process, including objectives. 5. Preparation of BUDGET that is translating decision packages into practicable units/items and
statement of budgetary objective & desired results. 6. The technique can also be used for introduction & allocating financial resources.
 Org. chart to show who is responsible for preparation of each functional budget implementation of system of ‘management by objective’. ZBB is an extension of cost benefit analysis method to area of corporate planning & budgeting.
& way in which budgets are interrelated.
 Timetable for preparation of each budget prevents formation of ‘bottleneck’
with late preparation of 1 budget holding up preparation of others.
ZBB Superior to Traditional Budgeting – How ? Traditional Budgeting v/s Zero Based Budgeting
 Copies of all forms to be completed by those responsible for preparing budgets, M‘18
with explanations concerning their completion. (5m)  Traditional budgeting is accounting  Zero-based budgeting makes a decision
 A list of organization’s account codes, with full explanations to use them. Zero based budgeting is superior to traditional budgeting in oriented. Main stress happens to be on oriented approach. It is very rational in
 Info. concerning key assumptions to be made by managers in their budgets, viz following manner: previous level of expenditure. nature and requires all programmes, old
rate of inflation, exch. rates, etc.  It provides a systematic approach for evaluation of different and new, to compete for scarce resources.
N’11 activities.  In traditional budgeting, first reference is  In zero- based budgeting, management
M’16 Fixed Budget v/s Flexible Budget  It ensures that function undertaken are critical for made to past level of spending and then focuses attention to only on decision
(4m) achievement of objectives. demand for inflation and new programmes packages, which enjoy priority to others.
 It is inflexible & does not change with  It can be re-casted according to the  It provides an opportunity for management to allocate  In tradition budgeting, some managers  In zero-based budgeting, a rationale
actual volume of output. level of activity. resources to various activities after a thorough – cost deliberately inflate their budget request so analysis of budget proposals is attempted.
 Operates under 1 level of activity & 1  It consists of various budgets for benefit analysis. that after the cuts they still get what they The managers, who unnecessarily try to
set of conditions. It assumes that different levels of activity.  It helps in identification of wasteful expenditure & then want inflate the budget request, are likely to be
conditions would remain static. their elimination. caught and exposed. Management accords
 Costs are not classified according to  Costs are classified according to  It facilitates close linkage of departmental budgets with its approval only to a carefully devised
their variability i.e., fixed, variable their variability i.e., fixed, variable corporate objectives. result-oriented package
and semi variable. and semi variable.  It helps in introduction of system of Management by  In traditional budgeting, it is for top  In Zero-based budgeting, this responsibility
 If budgeted & actual activity levels  Flexible budgeting at different levels Objectives. management to decide why a particular is shifted from top management to the
differ significantly, aspects like cost of activity facilitates ascertainment amount should be spent on a particular manager of decision unit.
ascertainment & price fixation do not of cost, fixation of selling price & decision unit.
give correct picture. tendering of quotations.

Budget & Budgetary Control
N‘11 N‘12 N‘13
Functional Budgets (2m) Essentials of Budget (4m) Capital Exp. Budget - Considerations (4m) Preparation of Budget – Steps involved
Budgets which relate to individual  Org. structure must be clearly defined & responsibility should be assigned to  Overhead on production facilities of  Definition of objectives : A budget is a plan for achievement of certain
functions in an org. are known as identifiable units. Setting of clear obj & reasonable targets. Obj. should be in certain departments as indicated by operational objectives, so these should be defined precisely.
Functional Budgets. consonance with org’s long term plan. plant utilisation budget.  Location of key factor : Factor(s) which sets a limit to total activity is known as
 Obj & degree of responsibility should be clearly communicated to mgmt./  Replacement requests from concerned key factor. For proper budgeting, it must be located & estimated properly.
Commonly used Functional budgets: responsible person. departments.  Appointment of controller : Formulation of budget usually requires whole
 Sales Budget  Budgets are prepared for future periods based on expected course of  Future development plans to increase time services of senior executive known as budget controller.
 Production Budget actions. Entire org. must be committed to budgeting output by expansion of plant facilities.  Budget Manual : Effective budgetary planning relies on provision of adequate
 Plant Utilisation Budget  Budgets are updated for events that were not kept into mind while  Factors like : information which are contained in budget manual.
 Direct Material Usage Budget establishing budgets. Hence, budgets should be flexible enough for mid-  sales potential to absorb the increased  Budget period : Period covered by budget is known as budget period. It may
 Direct Material Purchase Budget term revision. output, be months/quarters/such periods as coincide with period of trading activity.
 Direct Labour (Personnel) Budget  Budgets should be quantifiable & master budget should be broken down into  possibility of price reductions,  Standard of activity or output : Results of past should only be applied when
 Factory Overhead Budget various functional budgets.  increased costs of advertising and sales similar conditions are like to repeat in future.
 Production Cost Budget  Budgets should be monitored periodically. Variances from set standards promotion to absorb increased output,
should be analysed & responsibility should be fixed etc.
Advantages of Budgetary Control System Limitations of Budgetary Control System Advantages of Capital Exp. Budget
Operating Costing / Service Costing
1. Efficiency: Use of budgetary control system enables 1. Based on Estimates: Budgets are based on series 1. It outlines capital development
mgmt. to conduct its business activities efficiently. of estimates which are based on conditions program & estimated capital exp N’09, N’14
(4m) How to compute composite units?
2. Control on expenditure: It is a powerful instrument used prevailed when budget is established. during budget period.
by business houses for expenditure control. 2. Time factor : Some preliminary steps are required 2. It enables co. to establish system of
3. Finding deviations: It reveals deviations to mgmt., from to be accomplished before budgets are priorities. When there is shortage of  Operating Costing is a method of ascertaining costs of providing or operating
budgeted figures after making a comparison with implemented. funds, capital rationing becomes a SERVICE.
actual figures. 3. Co-operation: Required Staff co-operation is necessary.
4. Effective utilisation of resources: Effective utilisation of usually not available during budgetary control 3. Serves as tool for expenditure control.  It is usually used by transport companies, gas & water works departments,
various resources like—men, material, machinery & exercise. In a decentralised organisation each 4. It provides amount of exp. to be electricity supply companies, canteens, hospitals, theatres, schools etc.
money—is made possible, as production is planned after unit has its own objective and these units enjoy incorporated in future budget
taking them into account. some degree of discretion. summaries for calculation of estimated
5. Implementation of Standard Costing system : It creates 4. Expensive : Its implementation is quite expensive. return on capital employed. Computation of Composite Units :
suitable conditions for implementation of standard 5. Not a substitute for management: Budget is only a 5. Enables cash budget to be completed. When two units are merged into one, it is called Composite units. Composite
costing system in a business organisation. managerial tool & must be applied correctly for With other cash commitments, capital units i.e. tonnes kms., quintal kms. etc. may be computed in two ways :
6. Cost Consciousness: Budgets are studied by outside fund management to get benefited. expenditure commitment should also
providers also such as banking & financial institutions, 6. Rigid document : Budgets are considered as rigid be considered for completion of 1. Absolute (weighted average) tonnes-kms : Absolute tonnes-kms., are the
realising that mgmt. encourages cost consciousness & document. But in reality, an organisation is budget. sum total of tonnes-kms., arrived at by multiplying various distances by
maximum utilisation of available resources. exposed to various uncertain internal & external 6. It facilitates cost reduction programme, respective load quantities carried.
7. Credit Rating: Mgmt. which have developed a well factors. particularly when modernisation is 2. Commercial (simple average) tonnes-kms : Commercial tonnes-kms., are
ordered budget plan & which operate accordingly, covered by this budget. arrived at by multiplying total distance kms., by average load quantity.
receive greater favour from credit agencies.

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CA INTER

Costing Theory Smart Notes

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1 Introduction to C & MA 1.1 to 1.4

7 Unit Costing, Batch Costing & Job Costing 6.1

9 Contract Costing & Process Costing 7.1

10 Standard Costing & Marginal Costing 8.1

Costing Theory Smart Notes (CA Inter)

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