Cost Accounting Book

INTERMEDIATE : PAPER - 8
SYLLABUS -
2016
COST
ACCOUNTING INTERMEDIATE
STUDY NOTES
.
Contents
COST ACCOUNTING
Study Note 1 : Introduction to Cost Accounting
1.1 Definition, scope, objectives and significance of Cost Accounting, its relationship with
Financial Accounting and Management Accounting 1
1.2 Cost Objects, Cost Centers and Cost Units – Elements of Cost 8
1.3 Classification of Cost 14
1.4 Role of Cost Accountants in Organizations 23
Study Note 2 : Cost Ascertainment - Elements of Cost
2.1 Material Cost (CAS-6) 29

2.2 Employee Costs (CAS-7) 82
2.3 Direct Expenses (CAS-10) 133
2.4 Overheads (CAS-3) 137
Study Note 4 : Cost Book Keeping
4.1 Cost Accounting Records, Ledgers and Cost Statements 205

4.2 Items excluded from Cost and Normal and Abnormal Items/Cost 220
4.3 Non-Integrated Accounting 221
4.4 Integral Accounts 226
4.5 Reconciliation of Cost Accounting Records with Financial Accounts 236
4.6 Infrastructure, Educational, Healthcare and Port Services 249
Study Note 5 : Methods of Costing
5.1 Job Costing 261

5.2 Batch Costing 275
5.3 Contract Costing 279
5.4 Process Costing – Joint & By-Products 297
5.5 Operating Costing or Service Costing – Transport, Hotel and Hospital 329
Study Note 6 : Cost Accounting Techniques
6.1 Marginal Costing 353

6.2 Standard Costing & Variance Analysis 396
6.3 Budget and Budgetary Control 425
Cost Accounting
Study Note - 1
INTRODUCTION TO COST ACCOUNTING
THE INSTITUTE OF COST ACCOUNTANTS OF INDIA 1

COST ACCOUNTING
Cost Accounting : Cost Accounting may be defined as “Accounting for costs classification and analysis
of expenditure as will enable the total cost of any particular unit of production to be ascertained
with reasonable degree of accuracy and at the same time to disclose exactly how such total cost
is
constituted”. Thus Cost Accounting is classifying, recording an appropriate allocation of expenditure
for the determination of the costs of products or services.
Cost Accounting is the process of accounting for cost which begins with recording of income and
expenditure and ends with the preparation of statistical data. It is the formal mechanism by means
of which cost of products or services are ascertained and controlled.
It establishes budgets and standard costs and actual cost of operations, processes, departments or
products and the analysis of variances, profitability and social use of funds.
The technique in costing consists of the body of principles and rules for ascertaining the costs of
products and services.
Thus Cost Accounting is a quantitative method that collects, classifies, summarises and interprets
information for product costing, operation planning and control and decision making.
Costing : Costing is defined as the technique and process of ascertaining costs.
2 THE INSTITUTE OF COST ACCOUNTANTS OF INDIA

Introduction to Cost Accounting
Cost Accountancy: Cost Accountancy is defined as ‘the application of Costing and Cost Accounting
principles, methods and techniques to the science, art and practice of cost control and the
ascertainment of profitability’ .
is a science because it is a systematic body of knowledge having certain principles which a

accountant
cost should possess for proper discharge of his
(a) responsibilities.
It is an art as it requires the ability and skill with which a Cost Accountant is able to apply the
principles of Cost Accountancy to various managerial problems.
(b) Practice includes the continuous efforts of a Cost Accountant in the field of Cost
Accountancy.
Objectives of Cost Accounting
The following are the main objectives of Cost Accounting :-
(a) To
ascertain the Costs under different using different techniques and systems of costing
(b) To situations
determine the selling prices under different circumstances
(c) To determine and control efficiency
by setting standards for Materials, Labour and Overheads
(d) To determine the value of closing inventory
for preparing financial statements of the concern
(e) To provide a basis for operating
which may be determination of Cost Volume relationship,
policies
(f) To achieve real and permanent reduction in the unit cost of goods manufactured or services
rendered without impairing their suitability for the use intended or diminution in the quality of
the product.
Scope of Cost Accountancy

The scope of Cost Accountancy is very wide and includes the following:-
Cost Ascertainment:
(a) Cost Accounting:
(b) Analysis of Cost: .
(c) Cost Control: .
(d) Cost Reports:
(e) Cost Audit: .

COST ACCOUNTING
Financial Accounting and Cost Accounting:
Cost Accounting, as the name implies, is primarily concerned with determination of cost of something,
which may be a product, service, a process or an operation according to costing objective of
management. A Cost Accountant is primarily charged with the responsibility of providing cost data
for they may be required for.
whatever purposes
The main differences between Financial and Cost Accounting are as follows: M a i n Q u e s t i o
s n
Financial Accounting Cost Accounting
(a) It provides the information about the business (a) It provides information to the management
in a general way. i.e. Profit and Loss for proper planning, operation, control and
Account, Balance Sheet of the business to decision making.
owners and other outside partners.
(b) It classifies, records and analyses the (b) It records the expenditure in an objective
transactions in a subjective manner, i.e. manner, i.e. according to the purpose for
according to the nature of expense. which the costs are incurred.
(c) It lays emphasis on recording aspect (c) It provides a detailed system of control for
without attaching any importance to materials, labour and overhead costs with
control. the help of standard costing and budgetary
control.
(d) It reports operating results and financial (d) It gives information through cost reports to
position usually at the end of the year. management as and when desired.
(e) The users of financial accounting statements (e) The users of cost accounting information
are the various stakeholders i.e. shareholders, are generally internal management, officials
creditors, financial institutions, banks, and senior executives of the company.
government and its various agencies and
regulators.
(f) Generally the financial statements are (f) The cost reports and statements are
prepared periodically, for example, prepared as and when required by the
quarterly, halfyearly and yearly. management.
(g) There are standard formats used for (g) There are no such standard formats used
presentation of financial information. for presentation of cost accounting
information.
(h) Financial Accounts are accounts of the (h) Cost Accounting is only a part of the
whole business. They are independent in financial accounts and discloses profit or
nature. loss of each product, job or service.
(i) Financial Accounts records all the (i) Cost Accounting relates to transactions
commercial transactions of the business connected with Manufacturing of goods
and include all expenses i.e and services, means expenses which
Manufacturing, Office, Selling etc. enter into production.
(j) Financial Accounts are concerned with (j) Cost Accounts are concerned with internal
external transactions i.e. transactions transactions, which do not involve any cash
between business concern and third party. payment or receipt.

(k) Only transactions which can be measured in (k) Non-Monetary information likes No of Units /
monetary terms are recorded. Hours etc are used.
(l) Financial Accounting deals with actual (l) Cost Accounting deals with partly facts and
figures and facts only. figures and partly estimates / standards.
(m) Financial Accounting do not provide (m) Cost Accounts provide valuable information
information on efficiencies of various workers/ on the efficiencies of employees and Plant
Plant & Machinery. & Machinery.
(n) Stocks are valued at Cost or Market price (n) Stocks are valued at Cost only.
whichever is lower.
(o) Financial Accounting is a positive science as
(o) Cost Accounting is not only positive science
it is subject to legal rigidity with regarding
but also normative because it includes
to preparation of financial statements. techniques of budgetary control and
standard costing.
(p) These accounts are kept in such away to (p) Generally Cost Accounts are kept
meet the requirements of Companies Act voluntarily to meet the requirements of the
2013 as per Sec 128 & Income Tax Act, management, only in some industries Cost
1961 Sec 44AA. Accounting records are kept as per the
Companies Act.
Cost Accounting and Management Accounting

Management Accounting is primarily concerned with management. It involves application of
appropriate techniques and concepts, which help management in establishing a plan for reasonable
economic objective. It helps in making rational decisions for accomplishment of these objectives.
Any workable concept or techniques whether it is drawn from Cost Accounting, Financial Accounting,
Economics, Mathematics and Statistics, can be used in Management Accountancy. The data used
in Management Accountancy should satisfy only one broad test. It should serve the purpose that it is
intended for. A Management Accountant accumulates, summarizes and analysis the available data
and presents it in relation to specific problems, decisions and day-to-day task of management. A
Management Accountant reviews all the decisions and analysis from management’s point of view
to determine how these decisions and analysis contribute to overall organizational objectives. A
Management Accountant judges the relevance and adequacy of available data from management’s
point of view.
The scope of Management Accounting is broader than the scope of Cost Accountancy. In
Cost Accounting, primary emphasis is on cost and it deals with its collection analysis relevance
interpretation and presentation for various problems of management. Management Accountancy
utilizes the principles and practices of Financial Accounting and Cost Accounting
Advantages of Cost Accounting

COST ACCOUNTING
(i) Cost Accounting locates the exact causes for decrease or increase in the profit or loss of the
business. It identifies the unprofitable products or product lines so that these may be eliminated
or alternative measures may be taken.
(ii) Cost Accounts
furnish suitable data and information to the management to serve as guides in
making decisions involving financial considerations.
(iii) Cost Accounting is useful for price fixation purposes. Although sale price is generally related
more to economic conditions prevailing in the market than to cost, the latter serves as a guide
to test the adequacy of selling prices.
(iv) With the application of Standard Costing and Budgetary Control methods, the optimum level of
efficiency is set.
(v) Cost comparison helps in cost Comparison may be period to period, of the figures in
control. of the same unit or factory or of several units in an industry by employing Uniform
respect
Costs and Inter- Firm Comparison methods. Comparison may be made in respect of cost of
jobs, process or cost centres.
(vi) A cost system provides ready figures for use by the Government, wage tribunals and boards, and
labour and trade unions.
(vii) When a concern is not working to full capacity due to various reasons such as shortage of
demands or bottlenecks in the cost of idle capacity can readily worked out and
production, revealed to the
management.
(viii) Introduction of a cost reduction programme combined with operations research and value
analysis techniques leads to economy.
i
Marginal Costing is employed for suggesting courses of action to be taken. It is a useful tool for
x
the management for making decisions.
(ix) Determination of cost centres or responsibility centres to meet the needs of a Cost Accounting
system, ensures that the organizational structure of the concern has been properly laid
responsibility can be properly defined and fixed on individuals.
(x) Perpetual inventory system which includes a procedure for continuous stock taking is an
essential
feature of a cost
(xi) system.
and assists in furnishing correct and reliable cost data to the management as well as to outside
parties like shareholders, the consumers and the Government.


COST ACCOUNTING
1.2 COST OBJECTS, COST CENTERS AND COST UNITS – ELEMENTS OF COST
Cost: Cost is a measurement, in monetary terms, of the amount of resources used for the purpose of
production of goods or rendering services.
Cost in simple, words, means the total of all expenses. Cost is also defined as the amount of
expenditure
(actual
. or notional) incurred on or attributable to a given thing or to ascertain the cost of a given
Elements of Cost
Material Labour Expenses
Direct Materail Direct Labour Direct Expenses
Indirect Material Indirect Labour Indirect Expenses
Direct Material + Direct Labour + Direct Expenses = Prime Cost

Indirect Material+ Indirect Labour + Indirect Expenses = Overheads

Direct Material Cost

Direct material cost can be defined as‘The Cost of material which can be attributed to a cost object
in an economically feasible way’. Direct materials are those materials which can be identified in
the product and can be conveniently measured and directly charged to the product. Thus, these
materials directly enter the product and form a part of the finished product. For example, timber in
furniture making, cloth in dress making, bricks in building a house.
Indirect Material Cost
Indirect materials are those
which do not normally form a part of the finished It has
materials been defined as “
materials which cannot be allocated but which can be apportioned to or
product.
by cost centres or absorbed
cost units”. These are:
(i) Stores used in maintenance of machinery, buildings, etc., like lubricants, cotton waste, bricks
and cements
(ii) Stores used by the service i.e., non-productive departments like Power House, Boiler
House and Canteen, etc., and
departments,
(iii) Materials which due to their cost being small, are not considered worthwhile to be treated as
direct materials.
Direct Labour / Employee Cost

The cost of employees can be attributed to a cost object in an economically feasible way. In simple
words, it is that labour which can be conveniently identified or attributed wholly to a particular job,
product or process or expended in converting raw materials into finished goods. Wages of such labour
are known as direct wages. Thus it includes payment made to the following groups of labour:
(i) Labour engaged on the actual production of the product or in carrying out of an operation
or process
(ii) Labour engaged in adding the manufacture by way of supervision, maintenance, tool setting,
transportation of material etc.
(iii) Inspectors, analysts etc., specially required for such production
Indirect Labour/ Employee Cost
Direct or Chargeable Expenses

Direct expenses are expenses relating to manufacture of a product or rendering a service which
can be identified or linked with the cost object other than direct material cost and direct employee

COST ACCOUNTING
Direct expenses include all expenditure other than direct material or direct labour that is specifically
incurred for a particular product or process. Such expenses are charged directly to the particular cost
account concerned as part of the prime cost. Examples of direct expenses are: (i) GST;
(ii) Royalty; (iii) Architect or Supervisor’s fees; (iv) Cost of rectifying defective work; (v) Travelling
expenses to the city; (vi) Experimental expenses of pilot projects; (vii) Expenses of designing or drawings
of patterns or models; (viii) Repairs and maintenance of plant obtained on hire; and (ix) Hire of
special equipment obtained for a contract.
Overhead
Prime Cost
The aggregate of Direct Material, Direct Labour and Direct Expenses is called Prime Cost. Generally it
constitutes 50% to 80% of the total cost of the product, as such, as it is primary to the cost of the
product and called Prime Cost.
Cost Object
Cost object is the technical name for a product or a service, a project, a department or any activity
to which a cost relates. Therefore the term cost should always be linked with a cost object to be
more meaningful. Establishing a relevant cost object is very crucial for a sound costing system. The
Cost object could be defined broadly or narrowly. At a broader level a cost object may be named as
a Cost Centre, where as at a lowermost level it may be called as a Cost Unit.
In a manufacturing concern, the cost centres generally follow the pattern or layout of the
departments or sections of the factory and accordingly, there are two main types of cost centres as
below :-
(i) Production Cost Centre: These centres are engaged in production work i.e engaged in converting
the raw material into finished product, for example Machine shop, welding shops...etc
(ii) Service Cost Centre: These centres are ancillary to and render service to production cost centres,
for example Plant Maintenance, Administration...etc
The number of cost centres and the size of each vary from one undertaking to another and are
dependent upon the expenditure involved and the requirements of the management for the purpose
of control.

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In a manufacturing concern, the cost centres generally follow the pattern or layout of the
departments or sections of the factory and accordingly, there are two main types of cost centres as
below :-
(iii) Production Cost Centre: These centres are engaged in production work i.e engaged in converting
the raw material into finished product, for example Machine shop, welding shops...etc
(iv) Service Cost Centre: These centres are ancillary to and render service to production cost centres,
for example Plant Maintenance, Administration...etc
The number of cost centres and the size of each vary from one undertaking to another and are
dependent upon the expenditure involved and the requirements of the management for the purpose
of control.
.

COST ACCOUNTING
Cost Apportionment
When items of cost cannot be directly charged to or accurately identifiable with any cost centres,
they are prorated or distributed amongst the cost centres on some predetermined basis. This
method is known as cost apportionment. Thus we see that items of indirect costs residual to the
process of cost allocation are covered by cost apportionment. The predetermination of suitable basis
of apportionment is very important and usually following principles are adopted - (i) Service or use
(ii) Survey method (iii) Ability to bear. The basis ultimately adopted should ensure an equitable
share of common expenses for the cost centres and the basis once adopted should be reviewed at
periodic intervals to improve upon the accuracy of apportionment.
Cost Absorption
Ultimately the indirect costs or overhead as they are commonly known, will have to be distributed
over the final products so that the charge is complete. This process is known as cost absorption,
meaning thereby that the costs absorbed by the production during the period. Usually any of the
following methods are adopted for cost absorption - (i) Direct Material Cost Percentage (ii) Direct
Labour Cost Percentage (iii) Prime Cost Percentage (iv) Direct Labour Hour Rate Method (v) Machine
Hour Rate, etc. The basis should be selected after careful maximum accuracy of Cost Distribution to
various production units. The basis should be reviewed periodically and corrective action whatever
needed should be taken for improving upon the accuracy of the absorption.
Conversion Cost
This term is defined as the sum of direct wages, direct expenses and overhead costs of converting
raw material to the finished products or converting a material from one stage of production to
another stage. In other words, it means the total cost of producing an article less the cost of direct
materials used. The cost of indirect materials and consumable stores are included in such cost. The
compilation of conversion cost is useful in a number of cases. Where cost of direct materials is of
fluctuating nature, conversion cost is used to cost control purpose or for any other decision making.
In contracts/jobs where raw materials are on account of the buyers conversion cost takes the place
of total cost in the books of the producer. Periodic comparison/review of the conversion cost may
give sufficient insight as to the level of efficiency with which the production unit is operating.
Cost Control
Cost Control is defined as the regulation by executive action of the costs of operating an
undertaking, particularly where such action is guided by Cost Accounting. Cost control involves the
following steps and covers the various facets of the management:
Planning:
Communication:
Motivation.
Appraisal and Reporting:
Decision Making:

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Advantages of Cost Control

The advantages of cost control are mainly as follows
(i) Achieving the expected return on capital employed by maximising or optimizing profit
(ii) Increase in productivity of the available resources
(iii) Reasonable price of the customers
(iv) Continued employment and job opportunity for the workers
(v) Economic use of limited resources of production
(vi) Increased credit worthiness
(vii) Prosperity and economic stability of the industry
Cost Reduction
Broadly speaking reduction in cost per unit of production may be affected in two ways viz.,
(i) By reducing expenditure, the volume of output remaining constant, and
(ii) By increasing productivity, i.e., by increasing volume of output and the level of expenditure
remains unchanged.
Cost Control Cost Reduction

(a) Cost Control represents efforts made towards (a) Cost Reduction represents the achievement
achieving target or goal. in reduction of cost.
(b) The process of Cost Control is to set up a (b) Cost Reduction is not concern with
target, ascertain the actual performance maintenance of performance according to
and compare it with the target, investigate standard.
the variances, and take remedial measures.
(c) Cost Control assumes the existence of (c) Cost Reduction assumes the existence of
standards or norms which are not concealed potential savings in standards
challenged. or norms which are therefore subjected
to a constant challenge with a view to
improvement by bringing out savings.
(d) Cost Control is a preventive function. Costs (d) Cost Reduction is a corrective function. It
are optimized before they are incurred. operates even when an efficient cost control
system exists. There is room for reduction in
the achieved costs under controlled
conditions.
(e) Cost Control lacks dynamic approach. (e) Cost Reduction is a continuous process of
analysis by various methods of all the
factors affecting costs, efforts and functions
in an organization. The main stress is upon
the why of a thing and the aim is to have
continual economy in costs.

COST ACCOUNTING

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CLASSIFICATION OF COST
As per Cost Accounting Standard 1 (CAS-1), the basis for cost classification is as follows:
Classification of cost is the process of grouping the components of cost under a common designation
on the basis of similarities of nature, attributes or relations. It is the process of identification of each item
and the systematic placement of like items together according to their common features.
(a) Classification by Nature of Expense
Costs should be gathered together in their natural grouping such as Material, Labour and Other
Direct expenses. Items of costs differ on the basis of their nature. The elements of cost can be classified
in the following three categories. 1. Material 2. Labour 3. Expenses
Cost Classification by nature
Material Labour Expenses
Material Cost: Material cost is the cost of material of any nature used for the purpose of production
of a product or a service. It includes cost of materials, freight inwards, taxes & duties, insurance ...etc
directly attributable to acquisition, but excluding the trade discounts, duty drawbacks and refunds on
account of GST etc.
Labour Cost: Labour cost means the payment made to the employees, permanent or temporary for
their services. Labour cost includes salaries and wages paid to permanent employees, temporary
employees and also to the employees of the contractor. Here salaries and wages include all the
benefits like provident fund, gratuity, ESI, overtime, incentives...etc
Expenses: Expenses are other than material cost or labour cost which are involved in an activity.
(b) Classification by Relation to Cost Centre or Cost Unit
If expenditure can be allocated to a cost centre or cost object in an economically feasible way then
it is called direct otherwise the cost component will be termed as indirect. According to this criteria
for classification, material cost is divided into direct material cost and indirect material cost, Labour
cost is divided into direct labour and indirect labour cost and expenses into direct expenses and
indirect expenses. Indirect cost is also known as overhead.
Direct Indirect
Material Labour Expenses Material Labour Expenses
Direct Material Cost: Cost of material which can be directly allocated to a cost centre or a cost
object in an economically feasible way.
Direct labour Cost: Cost of wages of those workers who are readily identified or linked with a cost
centre or cost object.
Direct Expenses: Expenses other than direct material and direct labour which can be identified or
linked with cost centre or cost object.
Direct Material + Direct labour + Direct Expenses = Prime Cost

COST ACCOUNTING
Indirect Material : Cost of material which cannot be directly allocable to a particular cost centre or
cost object.
Indirect Labour : Cost of wages of employees which are not directly allocable to a particular cost
centre.
Indirect expenses: Expenses other than of the nature of material or labour and cannot be directly
allocable to a particular cost centre.
Indirect Material + Indirect Labour + Indirect Expenses = Overheads
(c) Classification by Functions
A business enterprise performs a number of functions like manufacturing, selling, research...etc.
Costs may be required to be determined for each of these functions and on this basis functional costs
may be classified into the following types:-
(i) Production or Manufacturing Costs
(ii) Administration Costs
(iii) Selling & Distribution cost
(iv) Research & Development costs
Cost classification by function
Production
Administration Research & Selling Distribution
Development
(i) Production or Manufacturing Costs: Production cost is the cost of all items involved in the
production of a product or service. These refer to the costs of operating the manufacturing division of
an undertaking and include all costs incurred by the factory from the receipt of raw materials and
supply of labour and services until production is completed and the finished product is packed with
the primary packing.
The followings are considered as Production or Manufacturing Costs:-
(1) Direct Material
(2) Direct Labour
(3) Direct Expenses and
(4) Factory overhead, i.e., aggregate of factory indirect material, indirect labour and indirect
expenses.
Manufacturing cost can also be referred to as the aggregate of prime cost and factory overhead.

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(ii) Administration Costs: Administration costs are expenses incurred for general management
of an organization. These are in the nature of indirect costs and are also termed as administrative
overheads. For understanding administration cost, it is necessary to know the scope of administrative
function. Administrative function in any organization is primarily concerned with following activities :-
1) Formulation of policy

COST ACCOUNTING
(i) Administration Costs: Administration costs are expenses incurred for general management of an
organization. These are in the nature of indirect costs and are also termed as administrative overheads.
For understanding administration cost, it is necessary to know the scope of administrative function.
Administrative function in any organization is primarily concerned with following activities :-
2) Formulation of policy
3) Directing the organization and
4) Controlling the operations of an organization. But administrative function will not include control
activities concerned with production, selling and distribution and research and development.
In most of the cases, administration cost includes indirect expenses of following types:
(1) Salaries of office staff, accountants, directors
(2) Rent, rates and depreciation of office building
(3) Postage, stationery and telephone
(4) Office supplies and expenses
(5) General administration expenses.
(ii)Selling & Distribution Costs: Selling costs are indirect costs related to selling of products or
services and include all indirect costs in sales management for the organization. Distribution costs are the
costs incurred in handling a product from the time it is completed in the works until it reaches the
ultimate consumer.
Following are the examples of selling and distribution costs:
(1) Salaries and commission of salesmen and sales managers
(2) Expenses of advertisement, insurance
(3) Rent, rates, depreciation and insurance of sales office and warehouses
(4) Cost of insurance, freight, export, duty, packing, shipping, etc.,
(5) Maintenance of Delivery vans
(iii) Research & Development Costs: Research & development costs are the cost for
undertaking research to improve quality of a present product or improve process of manufacture, develop
a new product, market research...etc. and commercialization thereof.
R&D Costs comprises of the following: -
(1) Development of new product
(2) Improvement of existing products
(3) Finding new uses for known products
(4) Solving technical problem arising in manufacture and application of products
(5) Development cost includes the costs incurred for commercialization/implementation of research
findings.
Pre-Production Costs:
These are costs incurred when a new factory is in the process of establishment, a new project is
undertaken, or a new product line or product is taken up but there is no established or formal
production to which such costs may be charged. Preproduction costs are normally treated as
deferred revenue expenditure and charged to the costs of future production.

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(d) Classification based on Behaviour – Fixed, Semi-variable or Variable

Costs are classified based on behaviour as fixed cost, variable cost and semi-variable cost depending
upon response to the changes in the activity levels.
Cost classification by behaviour
Fixed Variable Semi-variable

Fixed Cost: Fixed cost is the cost which does not vary with the change in the volume of activity in the
short run. These costs are not affected by temporary fluctuation in activity of an enterprise. These
are also known as period costs. Example: Rent, Depreciation...etc.
Variable Cost: Variable cost is the cost of elements which tends to directly vary with the volume of
activity. Variable cost has two parts (i) Variable direct cost (ii) Variable indirect costs. Variable indirect
costs are termed as variable overheads. Example: Direct labour, Outward Freight...etc.
Semi-Variable Costs: Semi variable costs contain both fixed and variable elements. They are partly
affected by fluctuation in the level of activity. These are partly fixed and partly variable costs and vice
versa. Example: Factory supervision, Maintenance...etc.
(e) Classification based on Costs for Management Decision Making
Ascertainment of cost is essential for making managerial decisions. On this basis costing may be
classified into the following types.
Marginal Costing: Marginal Cost is the aggregate of variable costs, i.e. prime cost plus variable
overhead. Marginal cost per unit is the change in the amount at any given volume of output by which
the aggregate cost changes if the volume of output is increased or decreased by one unit. Marginal
Costing system is based on the system of classification of costs into fixed and variable. The fixed costs
are excluded and only the marginal costs, i.e. the variable costs are taken into consideration for
determining the cost of products and the inventory of work-in-progress and completed products.
Differential Cost: Differential cost is the change in the cost due to change in activity from one level to
another.
Opportunity Cost: Opportunity cost is the value of alternatives foregone by adopting a particular
strategy or employing resources in specific manner. It is the return expected from an investment
other than the present one..
Replacement Cost: Replacement cost is the cost of an asset in the current market for the
purpose of replacement. Replacement cost is used for determining the optimum time of replacement
of an equipment or machine in consideration of maintenance cost of the existing one and its
productive capacity.

COST ACCOUNTING
Relevant Costs: Relevant costs are costs which are relevant for a specific purpose or situation. In the
context of decision making, only those costs are relevant which are pertinent to the decision at
hand..
Imputed Costs: Imputed costs are hypothetical or notional costs, not involving cash outlay computed
only for the purpose of decision making. In this respect, imputed costs are similar to opportunity
costs. Interest on funds generated internally, payment for which is not actually made is an example
of imputed cost..
Sunk Costs: Sunk costs are historical costs which are incurred i.e. sunk in the past and are not
relevant to the particular decision making problem being considered. Sunk costs are those that have
been incurred for a project and which will not be recovered if the project is terminated
Normal Cost & Abnormal Cost: Normal Cost is a cost that is normally incurred at a given level of
output in the conditions in which that level of output is achieved. Abnormal Cost is an unusual and
typical cost whose occurrence is usually irregular and unexpected and due to some abnormal situation of
the production.
Avoidable Costs & Unavoidable Costs: Avoidable Costs are those which under given conditions
of performance efficiency should not have been incurred. .
Controllable and Non-Controllable Costs: Controllable Cost is that cost which is subject to direct
control at some level of managerial supervision. Non-controllable Cost is the cost which is not subject
to control at any level of managerial supervision.

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(f) Classification by nature of Production or Process
Cost Classification by nature of Production or Process
Batch Process Operation Operating Contract Joint

Cost Cost Cost Cost Cost Cost
Batch Costing: Batch Costing is the aggregate cost related to a cost unit which consists of a group of
similar articles which maintains its identity throughout one or more stages of production. In this method,
the cost of a group of products is ascertained. The unit cost is a batch or group of identical products
instead of a single job, order, or contract. This method is applicable to general engineering factories
which produces components in convenient economical batches.
Process Costing: When the production process is such that goods are produced from a sequence
of continuous or repetitive operations or processes, the cost incurred during a period is considered
as Process Cost. The process cost per unit is derived by dividing the process cost by number of units
produced in the process during the period. Process Costing is employed in industries where a continuous
process of manufacturing is carried out. Costs are ascertained for a specified period of time by
departments or process. Chemical industries, refineries, gas and electricity generating concerns may
be quoted as examples of undertakings that employ process costing.
Operation Cost: Operation Cost is the cost of a specific operation involved in a production process
or business activity. The cost unit in this method is the operation, instead of process. When the
manufacturing method consists of a number of distinct operations, operation costing is suitable.
Operating Cost: Operating cost is the cost incurred in conducting a business activity. Operating cost
refer to the cost of undertakings which do not manufacture any product but which provide services.
Industries and establishments like power house, transport and travel agencies, hospitals, and schools,
which undertake services rather than the manufacture of products, ascertain operating costs. The
cost units used are Kilo Watt Hour (KWH), Passenger Kilo-meter and Bed in the hospital. etc. Operating
costing method constitutes a distinct type of costing but it may also be classed as a variant of Process
Cost since costs in this method are usually compiled for a specified period.
Contract Costing: Contract cost is the cost of contract with some terms and conditions between
contractee and contractor. This method is used in undertakings, carrying out, building or constructional
contracts like constructional engineering concerns, civil engineering contractors. The cost unit here is a
contract, which may continue over more than one financial year.
Joint Costs: Joint costs are the common cost of facilities or services employed in the output of two
or more simultaneously produced or otherwise closely related operations, commodities or services..
By-product Cost: By-product Cost is the cost assigned to by-products till the split-off point.

COST ACCOUNTING
(g) Classification by Time

A cost item is related to a specific period of time and cost can be classified according to the system
of assessment and specific purpose as indicated in the following ways :-
Classification by Time
Historical Pre-determined
Cost Cost
Standard Cost Estimated Cost
Historical Costs: Historical Costs are the actual costs of acquiring assets or producing goods or
services. They are post-mortem costs ascertained after they have been incurred and they represent
the cost of actual operational performance. Historical Costing follows a system of accounting to
which all values are based on costs actually incurred as relevant from time to time.
Predetermined Costs: Pre-determined Costs for a product are computed in advance of production
process, on the basis of a specification of all the factors affecting cost and cost data. Predetermined
Costs may be either standard or estimated.
Standard Costs: A predetermined norm applies as a scale of reference for assessing actual cost,
whether these are more or less. The Standard Cost serves as a basis of cost control and as a measure
of productive efficiency, when ultimately posed with an actual cost. It provides management with
a medium by which the effectiveness of current results is measured and responsibility of deviation
placed. Standard Costs are used to compare the actual costs with the standard cost with a view to
determine the variances, if any, and analyse the causes of variances and take proper measure to
control them.
Estimated Costs: Estimated Costs of a product are prepared in advance prior to the performance
of operations or even before the acceptance of sale orders. Estimated Cost is found with specific
reference to product in question, and the activity levels of the plant. It has no link with actual
and hence it is assumed to be less accurate than the Standard Cost.
Techniques of Costing
A. Marginal Costing
B. Standard Costing
C. Budgetary Control
D. Uniform Costing
A. Marginal costing
Marginal Costing is the ascertainment of marginal costs and of the effect on profit of changes in
volume or type of output by differentiating between fixed costs and variable costs. Several other
terms in use like Direct Costing, Contributory Costing, Variable Costing, Comparative Costing,
Differential Costing and Incremental Costing are used more or less synonymously with Marginal
Costing.

2
B. Standard Costing
Standard Cost is a predetermined cost unit that is calculated from the management’s standards
of efficient operation and the relevant necessary expenditure. The techniques of standard costing
may be summarised as follows :-
(i) Predetermination of technical data related to production. i.e., details of materials and labour
operations required for each product, the quantum of inevitable losses, efficiencies expected,
level of activity, etc.
(ii) Predetermination of standard costs in full details under each element of cost, viz., labour,
material and overhead.
(iii) Comparison of the actual performance and costs with the standards and working out the
variances, i.e., the differences between the actual and the standards.
(iv) Analysis of the variances in order to determine the reasons for deviations of actuals from the
standards.
(v) Presentation of information to the appropriate level of management to enable suitable action
(remedial measures or revision of the standard) being taken.
C. Budgetary Control
Budgetary Control may be defined as the process of continuous comparison of actual costs and
performance with the pre-established budgets in relation to the responsibilities of the executives to
the specific budgets for the achievement of a target in accordance with the policy of the organization
and to provide a basis for revision of budget.
.
D. Uniform Costing
Uniform Costing may be defined as the application and use of the same costing principles and
procedures by different Organizations under the same management or on a common understanding
between members of an association.

COST ACCOUNTING
GLOSSARY
Activity based Costing (ABC): Activity based Costing is a system that focuses on activities as the
fundamental cost objects and uses the cost of these activities for compiling the costs of products and
other cost objects. The product cost is built up from the cost of the specific activities undertaken to
manufacture it.
Conversion Cost: Conversion Cost is the cost of converting material input into semi−finished or finished
products i.e. the cost incurred in additional direct materials, direct wages, direct expenses and
absorbed overhead.
Cost Absorption: Cost Absorption is the process of charging to the cost units by means of rates.
Cost Accountancy: Cost Accountancy is the application of costing and cost accounting
principles, methods and techniques to the science, art and practice of cost control and the
ascertainment of profitability. It includes the presentation of information derived therefrom for the
purpose of managerial decision making.
Cost Accounting: Cost Accounting is a process of accounting for cost which begins with the
recording of income and expenditure or the bases on which they are calculated and ends with the
preparation of periodical statements and reports for ascertaining and controlling costs.
Cost Allocation: Cost Allocation is that part of cost attribution which charges specific cost to a cost
centre or cost unit.

4
Cost Apportionment: Cost Apportionment is that part of cost attribution which shares costs among two
or more cost centers or cost units in proportion to the estimated benefit received.
Cost Audit: Cost Audit is the verification of correctness of cost accounts and check on the
adherence to the cost accounting plan. Its purpose is not only to ensure the arithmetical accuracy of
cost records but also to ensure that the principles and rules have been applied correctly.
Cost Centre: Cost Centre is a location, function or items of equipment in respect of which costs may
be ascertained and related to cost units for control purposes.
Cost Control: Cost Control is the process of regulating the action so as to keep the element of cost
within the set parameters.
Cost Driver: Cost Driver is the factor influencing the level of cost, often used in the context of ABC
to denote the factor which links activity resource consumption to produce outputs, for example, the
number of purchase orders would be a cost driver for procurement cost.
Cost Management: Cost Management is an application of management accounting concepts,

methods of collections, analysis and presentation of data to provide the information needed to plan,
monitor and control costs.
Cost Object: Cost Object is anything for which a separate measurement of cost is required. Cost
object may be a product, a service, a project, a customer, a brand category, an activity, a
department or a program etc.
Cost Reduction: Cost Reduction is the achievement of real and permanent reduction in the unit
cost of goods manufactured or services rendered without impairing their suitability for the use
intended or diminution in the quality of the product.
Cost Unit: Cost Unit is a unit of product or service in relation to which costs are ascertained.
Cost: Cost is the amount of expenditure (actual or notional) incurred on or attributable to a specified
article, product or activity.
Costing: Costing is the technique and process of ascertaining costs.
Financial Accounting: Financial Accounting is the organization and presentation of a firm’s accounts
for information of the management as well as the various stakeholders.
Investment Centre: Investment Centre is a profit Centre whose performance is measured by its return
on capital employed.
Management Accounting: Management Accounting is the application of the principles of

accounting and financial management to create, protect, preserve and increase value for the
stakeholders of for−profit and not−for−profit enterprises in the public and private sectors.
Profit Centre: The Profit Centre is a part of business accountable for costs and revenues.
Responsibility Centre: A Responsibility Centre is a unit or function of an organization headed by a

manager having direct responsibility for its performance.
Revenue Centre: The Revenue Centre is a responsibility Centre which is accountable for generation
of revenue for the organization.
Sunk Cost: Sunk Cost is the cost incurred in purchasing a capital asset. Depreciation is in the nature of
a recovery of sunk cost due to the past management decision.

COST ACCOUNTING

6

COST ACCOUNTING

8
Study Note - 2
COST ASCERTAINMENT - ELEMENTS OF COST
This Study Note includes
2.1 Material Costs (CAS - 6)

2.2 Employee Costs (CAS - 7)
2.3 Direct Expenses (CAS - 10)
2.4 Overheads (CAS - 3)
2.1 MATERIAL COST (CAS-6)
Material is a substance (Physics term) that forms part of or composed of a finished product. i.e
material
Objectives of Material Control System

Material Control: The function of ensuring that sufficient goods are retained in stock to meet all
requirements without carrying unnecessarily large stocks.
The objectives of a system of material control are as following:-
(a) To make continuous availability of materials so that there may be uninterrupted flow of
materials for production. Production may not be held up for want of materials.
(b) To purchase requisite quantity of materials to avoid locking up of working capital and to minimise
risk of surplus and obsolete stores
(c) To make purchase competitively and wisely at the most economical prices so that there may be
reduction of material costs
(d) To purchase proper quality of materials to have minimum possible wastage of materials
(e) To serve as an information centre on the materials knowledge for prices, sources of supply, lead
time, quality and specification

COST ACCOUNTING
Economic Order Quantity: (EOQ)

The total costs of a material usually consist of Buying Cost + Total Ordering Cost + Total Carrying Cost.
Economic Order Quantity is ‘The size of the order for which both ordering and carrying cost are
minimum’.
Ordering Cost: The costs which are associated with the ordering of material. It includes cost of
staff posted for ordering of goods, expenses incurred on transportation, inspection expenses of
incoming material. etc
Carrying Cost: The costs for holding the inventories. It includes the cost of capital invested in
inventories. Cost of storage, Insurance. etc
The assumptions underlying the Economic Ordering Quantity (EOQ): The calculation of economic
order of material to be purchased is subject to the following assumptions:-
(a) Ordering cost per order and carrying cost per unit per annum are known and they are fixed.
(b) Anticipated usage of material in units is known.
(c) Cost per unit of the material is constant and is known as well.
(d) The quantity of material ordered is received immediately i.e lead time is Zero.
The famous mathematician ‘WILSON’ derived the formula used for determining the size of order for
each purchases at minimum ordering and carrying costs, which is as below :-
2AO
Economic Ordering Quantity =
C
Where,
A = Annual demand /Consumption
O = Ordering Cost per order
C = Carrying Cost per unit per annum.
Illustration 1
Calculate the Economic Order Quantity from the following information. Also state the number of
orders to be placed in a year.
Consumption of materials per annum : 10,000 kg
Order placing cost per order : ` 50
Cost per kg. of raw materials : `2
Storage costs : 8% on average inventory
Solution:
2 ×A×O
EOQ =
C
A = Units consumed during year = 10,000 Kg.
O = Order cost per order = `50

C = Inventory carrying cost per unit per annum 2 × 8% = `
2 ×10,000 (units) × `
0.16 EOQ =
50
` 0.16
EOQ = 2,500 kg.
No. of orders to be placed in a year Total consumption of materials per

= annum
EOQ
10,000 kg
= 2,500 kg
= 4 Orders per year

COST ACCOUNTING
Illustration 2
The average annual consumption of a material is 18,250 units at a price of ` 36.50 per unit. The storage
cost is 20% on an average inventory and the cost of placing an order is ` 50. How much quantity is
to be purchased at a time?
Solution:
2 ×18,250 (units) × `
EOQ =
50
20% of ` 36.50
18,25,000
= 7.3
= 500 Units
Maximum Level
The Maximum Level indicates the maximum quantity of an item of material that can be held in stock
at any time. The stock in hand is regulated in such a manner that normally it does not exceed this
level.

While fixing the level, the following factors are to be taken into consideration:
(a) Maximum requirement of the store for production purpose, at any point of time
(b) Rate of consumption and lead time
(c) Nature and properties of the Store: For instance, the maximum level is necessarily kept low for
materials that are liable to quick deterioration or obsolescence during storage.
(d) Storage facilities that can be conveniently spared for the item without determinant to the
requirements of other items of stores.
(e) Cost of storage and insurance
(f) Economy in prices: For seasonal supplies purchased in bulk during the season, the maximum
level is generally high.
(g) Financial considerations: Availability of funds and the price of the stores are to be kept in view.
For costly items, the maximum level should be as low as possible. Another point to be
considered is the future market trend. If prices are likely to rise, the concern may like to stock-
piling for keeping large stock in reserve for long-term future uses and in such a case, the level
is pushed up.
(h) Rules framed by the government for import or procurement. If due to these and other causes
materials are difficult to obtain and supplies are irregular the maximum level should be high.
(i) The maximum level is also dependent on the economic ordering quantity.
Maximum Level = Re-Order Level + Re-Order Qty – (Minimum Rate of Consumption × Minimum Re-
Order Period)
Minimum Level
The Minimum Level indicates the lowest quantitative balance of an item of material which must
be maintained at all times so that there is no stoppage of production due to the material being
not available. In fixing the minimum level, the following factors are to be considered :-
(a) Nature of the item: For special material purchased against customer’s specific orders, no
minimum level is necessary. This applies to other levels also.
(b) The minimum time (normal re-order period) required replenishing supply: This is known as the Lead
Time and are defined as the anticipated time lag between the dates of issuing orders and the
receipt of materials. Longer the lead time, lower is minimum level, the re-order point remaining
constant.
(c) Rate of consumption (normal, minimum or maximum) of the material.
Minimum Level = Re-Order level – (Normal Rate of Consumption × Normal Re-Order
Period) Re-Order Level
When the stock in hand reach the ordering or re-ordering level, store keeper has to initiate the
action for replenish the material. This level is fixed somewhere between the maximum and minimum
levels in such a manner that the difference of quantity of the material between the Re-ordering
Level and Minimum Level will be sufficient to meet the requirements of production up to the time
the fresh supply of material is received.
The basic factors which are taken into consideration in fixing a Re-ordering Level for a store
item include minimum quantity of item to be kept, rate of consumption and lead time which are
applied for computing of this level.

COST ACCOUNTING
Re-Ordering level = Minimum Level + Consumption during lead time

= Minimum Level + (Normal Rate of Consumption × Normal Re-order Period)
Another formula for computing the Re-Order level is as below:

Re-Order level = Maximum Rate of Consumption × Maximum Re-Order period (lead time)

Danger Level
It is the level at which normal issue of raw materials are stopped and only emergency issues are only
made. This is a level fixed usually below the Minimum Level. When the stock reaches this level very
urgent action for purchases is indicated. This presupposed that the minimum level contains a cushion
to cover such contingencies. The normal lead time cannot be afforded at this stage. It is necessary to
resort to unorthodox hasty purchase procedure resulting in higher purchase cost.
The practice in some firms is to fix danger level below the Re-Ordering Level but above the Minimum
Level. In such case, if action for purchase of an item was taken when the stock reached the Re-
Ordering Level, the Danger Level is of no significance except that a check with the purchases
department may be made as soon as the Danger Level is reached to ensure that everything is all
right and that delivery will be made on the scheduled date.
Danger Level = Normal Rate of Consumption × Maximum Reorder Period for emergency purchases
Illustration 3
The components A and B are used as follows:
Normal usage...........................300 units per week each
Maximum usage......................450 units per week each
Minimum usage.......................150 units per week each
Reorder Quantity.......................A 2,400 units; B 3,600 units.
Reorder period.........................A 4 to 6 weeks, B 2 to 4 weeks.
Calculate for each component:
(a) Re-order Level (b) Minimum Level (c) Maximum Level (d) Average Stock Level.
Solution:
Particulars A B
a) Reorder Level 2700 units 1800 units
[Max. Consumption × Max. Re-order (450 × 6) (450 × 4)
Period]
b) Minimum Level
[ROL – (Normal Consumption × Normal 1200 units 900 units
Re-order period)] [2700 – (300×5)] [1800 – (300×3)]
c) Maximum Level
[ROL + ROQ – (Min. Consumption × 4500 units 5100 units
Min. Re-order Period)] [2700 + 2400 – (150×4)] [1800 + 3600 – (150 × 2)]
d) Average Stock Level 2850 units 3000 units
[Min. Level + Max. Level] / 2 [4500 + 1200]/2 [5100 + 900]/2
OR (or) (or)
[Min. Level + ½ Re-order Quantity] 2400 units 2700 units
1200 + ½ (2400) 900 + ½ (3600)

COST ACCOUNTING

Difference between Bin Card and Stores Ledger
Bin Card Stores Ledger

(a) It is maintained by the store keeper. (a) It is maintained in the Costing department.
(b) It contains only quantitative details of (b) It contains information both in quantity and value.
materials received, issued and returned to
stores.
(c) Entries are made when transactions take (c) It is always posted after the transaction.
place.
(d) Each transaction is individually posted. (d) Transactions may be summarized and then
posted.
(e) Inter-department transfers do not appear (e) Material transfers from one job to another job
in Bin-card. are
recorded for costing purpose.

COST ACCOUNTING
Perpetual Inventory System

Perpetual Inventory System may be defined as ‘a system of records maintained by the controlling
department, which reflects the physical movements of stocks and their current balance’. Thus it is a
system of ascertaining balance after every receipt and issue of materials through stock records to
facilitate regular checking and to avoid closing down the firm for stock taking. To ensure the
accuracy of the perpetual inventory records (bin card and Stores ledger), physical verification of
stores is made by a program of continuous stock taking.
Advantages of perpetual inventory system

(a) The system obviates the need for the physical checking of all items of stock and stores at the
end of the year.
(b) It avoids the dislocation of the routine activities of the organization including production and
dispatch.
(c) A reliable and detailed check on the stores is maintained.
(d) Errors, irregularities and loss of stock through other methods are quickly detached and through
necessary action recurrence of such things in future is minimized.

ABC Analysis
The “ABC Analysis” is an analytical method of stock control which aims at concentrating efforts on
those items where attention is needed most. It is based on the concept that a small number of the
items in inventory may typically represent the bulk money value of the total materials used in
production process, while a relatively large number of items may present a small portion of the
money value of stores used resulting in a small number of items be subjected to greater degree of
continuous control.
Under this system, the materials stocked may be classified into a number of categories according to
their importance, i.e., their value and frequency of replenishment during a period. The first category
(we may call it group ‘A’ items) may consist of only a small percentage of total items handled but
combined value may be a large portion of the total stock value. The second category, naming it as
group ‘B’ items, may be relatively less important. In the third category, consisting of group ‘C’ items,
all the remaining items of stock may be included which are quite large in number but their value is
not high.

COST ACCOUNTING
This concept may be clear by the following example:
Category No. of Items % of the Total Value % of the Average Value

No. of Items Amount (`) Total Value Amount (`)
Item
A 75 6 70,000 70 933
B 375 30 20,000 20 53
C 800 64 10,000 10 12
1250 100 1,00,000 100 998
Category ‘A’ items represent 70% of the total investment but as little as only 6% of the number of items.
Maximum control must be exercised on these items. Category ‘B’ is of secondary importance and
normal control procedures may be followed. Category ‘C’ comprising of 64% in quantity but only
10% in value, needs a simpler, less elaborate and economic system of control.
The advantages of ABC analysis are:
(a) Closer and stricter control of those items which represent a major portion of total stock value is
maintained.
(b) Investment in inventory can be regulated and funds can be utilised in the best possible manner.
‘A’ class items are ordered as and when need arises, so that the working capital can be utilised
in a best possible way.
(c) With greater control over the inventories, savings in material cost will be realised.
(d) It helps in maintaining enough safety stock for ‘C’ category of items.
(e) Scientific and selective control helps in the maintenance of high stock turnover ratio.
VED Analysis
VED stands for Vital, Essential and Desirable- analysis is used primarily for control of spare parts.
The spare parts can be classified in to three categories i.e Vital, Essential and Desirable- keeping in
view the criticality to production.
Vital: The spares, stock-out of which even for a short time will stop the production for quite some time,
and where in the stock-out cost is very high are known as Vital spares. For a car Assembly Company,
Engine is a vital part, without the engine the assembly activity will not be started.
Essential: The spares or material absence of which cannot be tolerated for more than few hours or
a day and the cost of lost production is high and which is essential for production to continue are
known as Essential items. For a car assembly company ‘Tyres’ is an essential item, without fixing the
tyres the assembly of car will not be completed.
Desirable: The Desirable spares are those parts which are needed, but their absence for even a week
or more also will not lead to stoppage of production. For example, CD player, for a car assembly
company.

Just-in-Time
Just in time (JIT) is a production strategy that strives to improve a business return on investment by
reducing in-process inventory and associated carrying costs. Inventory is seen as incurring costs, or
waste, instead of adding and storing value, contrary to traditional accounting. In short, the Just-in-
Time inventory system focuses on “the right material, at the right time, at the right place, and in the
exact amount” without the safety net of inventory.
The advantages of Just-in-Time system are as follows :-
(a) Increased emphasis on supplier relationships. A company without inventory does not want a
supply system problem that creates a part shortage. This makes supplier relationships
extremely important.
(b) Supplies come in at regular intervals throughout the production day. Supply is synchronized
with production demand and the optimal amount of inventory is on hand at any time. When
parts move directly from the truck to the point of assembly, the need for storage facilities is
reduced.
(c) Reduces the working capital requirements, as very little inventory is maintained.
(d) Minimizes storage space.
(e) Reduces the chance of inventory obsolescence or damage.
Inventory Turnover Ratio

Inventory Turnover signifies a ratio of the value of materials consumed during a given period to the
average level of inventory held during that period. The ratio is worked out on the basis of the
following formula:
Value of material consumed during the period
Inventory Turnover Ratio = Value of average stock held during the period
The purpose of the above ratio is to ascertain the speed of movement of a particular item. A high
ratio indicates that the item is moving fast with a minimum investment involved at any point of time.
On the other hand a low ratio indicates the slow moving item. Thus Inventory Turnover Ratio may
indicate slow moving dormant and obsolet stock highlighting the need for appropriate managerial
actions.
Illustration 4
Compute the Inventory turnover ratio from the following:
Opening Stock - ` 10,000
Closing Stock - ` 16,000
Material Consumed - ` 78,000
Solution :
Value of material consumed during the period
Inventory Turnover Ratio = Value of average stock held during the period
Opening Stock  Closing Stock

Average Stock =
2
10,000  16,000
= = 13,000
2
78,000
 Inventory Turnover Ratio =
13,000
COST ACCOUNTING
= 6. (times)

COST ACCOUNTING
We may now briefly discuss all the above methods

(1) First in – First Out Method
It is a method of pricing the issue of materials in the order in which they are purchased. In other
words the materials are issued in the order in which they arrive in the store. This method is considered
suitable in times of falling price because the material cost charged to production will be high while the
replacement cost of materials will be low. In case of rising prices this method is not suitable.
Advantages of FIFO
(a) It is simple and easy to operate.
(b) In case of falling prices, this method gives better results.
(c) Closing stocks represents the market prices.

Disadvantages
(a) If the prices fluctuate frequently, this method may lead to clerical errors.
(b) In case of rising prices this method is not advisable.
(c) The material costs charged to same job are likely to show different rates.
(2) Last-in-First Out Method
Under this method the prices of last received batch (lot) are used for pricing the issues, until it is
exhausted and so on. During the inflationary period or period of rising prices, the use of LIFO would
help to ensure the cost of production determined approximately on the above basis is approximately
the current one. Under LIFO stocks would be valued at old prices, but not represent the current
prices.
Advantages
(a) The cost of materials issued will be either nearer to and/or will reflect the current market price.
(b) In case of falling prices profit tends to rise due to lower material cost
Disadvantages
(a) The computations become complicated if too many receipts are there.
(b) Companies having JIT system will face this problem more.
(3) Base Stock Method
A minimum quantity of stock under this method is always held at a fixed price as reserve in the stock, to
meet a state of emergency, if arises. This minimum stock is known as Base Stock and is valued at a price
at which the first lot of materials is received and remains unaffected by subsequent price fluctuations.
The quantity in excess of the base stock may be valued either on the LIFO basis or FIFO basis. This
method is not an independent method as it uses FIFO or LIFO. Its advantages and disadvantages
therefore will depend upon the use of the other method.
(4) Specific Price Method
This method is useful, especially when the materials are purchased for a specific job or work order,
and as such these materials are issued subsequently to that specific job or work order at the price at
which they were purchased. The cost of materials issued for production purposes to specific jobs
represent actual and correct costs. This method is specific for non-standard products. This method is
difficult to operate, especially when purchases and issues are numerous.
(5) Simple Average Price Method
Under this method materials issued are valued at average price, which is computed by dividing the
total of all units rate by the number of units.
Material Issue Price = Total of unit prices of each purchase / Total No of Units
This method is useful, when the materials are received in uniform lots of similar quantity and prices
do not fluctuate considerably.
(6) Weighted Average Price Method
This method removes the limitation of Simple Average Method in that it also takes into account the
quantities which are used as weights in order to find the issue price. This method uses total cost of
material available for issue divided by the quantity available for issue.

COST ACCOUNTING
Issue Price = Total Cost of Materials in stock / Total Quantity of Materials in stock

(7) Moving Simple Average Price Method
Under this method the rate for material issue is determined by dividing the total of the periodic
simple average prices of a given number of periods by the number of periods. For determining the
moving simple average price, it is necessary to fix up first period to be taken for determining the
average. Suppose a three monthly period is decided upon and moving average rate for the month of
April is to be computed. Under such situation, we have to make a simple list of the simple average
price from January to March, add them up, and divide the total by three. To compute the moving
average for May, we have to omit simple average rate pertains to January and add the rate relating
to the April and divide the total by three.
(8) Moving Weighted Average Price Method
Under this method, the issue, rate is computed by dividing the total of the periodic weighted average
price of a given number of periods by the number of periods.
(9) Replacement Method
Replacement price is defined as the price at which it is possible to purchase an item, identical to that
which is being replaced or revalued. Under this method, materials issued are valued at replacement
cost of the items. Advantage of this method is issue cost reflects the current market price. But the
difficult involved under this method is determination of market price of material before each issue.
(10)Realisable Price method
Realisable price means a price at which the material to be issued can be sold in the market. This
price may be more or less than the cost price, at which it was originally purchased.
(11)Standard Price Method
Under this method, materials are priced at some predetermined rate of standard price irrespective of
the actual purchase cost of the materials. Standard cost is usually fixed after taking into
consideration the current price, anticipated market trends. This method facilitates the control of
material cost and task of judging the efficiency of purchase department. But it is very difficult to fix
the standard price when the prices fluctuates frequently.
(12) Inflated Price Method
In case of materials that suffers loss in weight due to natural or climatic factors ex: evaporation...etc
the issue price of the materials is inflated to cover up the losses.
Illustration 5
Prepare a statement showing the pricing of issues, on the basis of
(a) Simple Average and
(b) Weighted Average methods from the following information pertaining to Material-D
2016 March 1 Purchased 100 units @ `10 each
2 Purchased 200 units @ ` 10.2 each.
5 Issued 250 units to Job X vide M.R.No.12
7 Purchased 200 units @ `10.50 each
10 Purchased 300 units @ `10.80 each
13 Issued 200 units to Job Y vide M.R.No.15
18 Issued 200 units to Job Z vide M.R.No.17
20 Purchased 100 units @ `11 each
25 Issued 150 units to Job K vide M.R.No.25

COST ACCOUNTING
Solution:
(a) Simple Average Method:
Stores Ledger Account
Receipts Issue Balance
Qty. Price Value Qty. Price Value Qty. Value
Date
Amount (`) Amount (`) Amount (`) Amount (`) Amount (`)
2016
March 1 100 10 1000 -- -- -- 100 1000
March 2 200 10.2 2040 -- -- -- 300 3040
March 5 -- -- -- 250 10.10 (1)
2525 50 515
March 7 200 10.5 2100 -- -- -- 250 2615
March 10 300 10.8 3240 -- -- -- 550 5855
March 13 -- -- -- 200 10.50 (2)
2100 350 3755
March 18 -- -- -- 200 10.65 (3)
2130 150 1625
March 20 100 11 1100 -- -- -- 250 2725
March 25 -- -- -- 150 10.90 (4)
1635 100 1090
Working Notes:
1. Calculation of Price for Issue on March 5th
= (10 + 10.2) / 2 = `10.10
= (10.2 + 10.5 + 10.8) / 3 = `10.5
= (10.5 + 10.8) / 2 = `10.65
= (10.8 + 11) / 2 = `10.90
(b) Weighted Average Method:

Stores Ledger Account
Qty. Price Value Qty. Price Value Qty. Value
Date
Amount (`) Amount (`) Amount (`) Amount (`) Amount (`)
2016
March 1 100 10 1000 -- -- -- 100 1000
March 2 200 10.2 2040 -- -- -- 300 3040
March 5 -- -- -- 250 10.13 (1)
2533 50 507
March 7 200 10.5 2100 -- -- -- 250 2607
March 10 300 10.8 3240 -- -- -- 550 5847
March 13 -- -- -- 200 10.63 (2)
2126 350 3721
March 18 -- -- -- 200 10.63 (3)
2126 150 1595
March 20 100 11 1100 -- -- -- 250 2695
March 25 -- -- -- 150 10.78 (4)
1617 100 1078

Working Notes:
1. Calculation of price for Issue on March 5th
= 3040/300 = `10.13

= 5847/550 = `10.63

= 3721/350 = `10.63

= 2695/250 = `10.78
Illustration 6
The stock of material held on 1-4-2015 was 400 units @ 50 per unit. The following receipts and issues
were recorded. You are required to prepare the Stores Ledger Account, showing how the values of
issues would be calculated under Base Stock Method, both through FIFO AND LIFO base being 100
units.
2-4-2015 Purchased 100 units @`55 per unit
6-4-2015 Issued 400 units
10-4-2015 Purchased 600 units @ `55 per unit
20-4-2015 Purchased 500 units @ `65 per unit.
15-6-2015 Purchased 300 units @ ` 80 per unit

COST ACCOUNTING
1. Scrap
This is also in the form of incidental material residue coming out of certain types of
manufacturing processes, but it is usually in small amounts and has low measurable utility or
market value, recoverable without further processing. Numerous examples of scrap may be given;
scrap may arise in the form of turnings, borings, trimmings, fillings, shavings etc., from metals on which
machine operations are carried out; saw dust and trimmings in the timber industry; dead heads
and bottom ends in foundries; and cuttings, pieces, and split in leather industries. Scrap should
always be physically available unlike waste which may or may not be present in the form of a
residue.
2. Spoilage
Definition: When production does not come up to the standard specifications or quality it has to be
rejected outright. The components or materials are so damaged in the manufacturing process that
they cannot be brought back to normal specifications by repairs or reconditioning. Some spoiled
work may be sold as seconds but in most cases, the entire production is sold for small value in the
form of scrap or treated as waste if it has no market value. Spoilage involves not only loss of
materials but also of labor and manufacturing overhead incurred up to the stage when the spoilage
incurred.

Illustration 7
Prepare a Stores Ledger Account from the following information adopting FIFO method of pricing of
issues of materials.
2016 March 1. Opening Balance 500 tonnes @ `200
3. Issue 70 tonnes
4. Issue 100 tonnes
5. Issue 80 tonnes
13. Received from suppliers 200 tonnes @ `190
14. Returned from Department A 15 tonnes.
16. Issued 180 tonnes
20. Received from supplier 240 tonnes @ `195
24. Issue 300 tonnes
26. Issue 115 tonnes
27. Returned from Department B 35 tonnes
Solution:
Stores Ledger Account [FIFO Method]

Qty. Price Value Qty. Price Value Qty. Price Value
Date Amount Amount Amount Amount Amount Amount (`)
(`) (`) (`) (`) (`)
2016
March 1 -- -- -- -- -- -- 500 200 1,00,000
March 3 -- -- -- 70 200 14,000 430 200 86,000
March 4 -- -- -- 100 200 20,000 330 200 66,000
March 5 -- -- -- 80 200 16,000 250 200 50,000
March 13 200 190 38,000 -- -- -- 250 200 50,000
200 190 38,000
March 14 15 200 3,000 -- -- -- 250 200 50,000

COST ACCOUNTING
200 190 38,000

15 200 3,000
March 16 -- -- -- 180 200 36,000 70 200 14,000
200 190 38,000
15 200 3,000
March 20 240 195 46,800 -- -- -- 70 200 14,000
200 190 38,000
15 200 3,000
240 195 46,800
March 24 -- -- -- 70 200 14,000 -- -- --
200 190 38,000 -- -- --
15 200 3,000 -- -- --
15 195 2,925 225 195 43,875
March 25 320 200 64,000 -- -- -- 225 195 43,875
320 200 64,000
March 26 -- -- -- 115 195 22,425 110 195 21,450
320 200 64,000
March 27 35 195 6,825 -- -- -- 110 195 21,450
320 200 64,000
35 195 6,825
March 28 100 200 20,000 -- -- -- 110 195 21,450
320 200 64,000
35 195 6,825
100 200 20,000

COST ACCOUNTING
Illustration 12
Two components A and B are used as follows:
Normal usage = 50 per week each
Re-order quantity = A- 300; B-500
Maximum usage = 75 per week each
Minimum usage = 25 per week each
Re-order period: A - 4 to 6 weeks; B - 2 to 4 weeks
Calculate for each component
(a) Re-order level; (b) Minimum level; (c) Maximum level; (d) Average stock level.
Solution:
Particulars A B
a) Reorder Level 450 units 300 units
[Max. Consumption × Max. Re-order Period] (75 x 6) (75 x 4)
b) Minimum Level
[ROL – (Normal Consumption x Normal Re-order 200 units 150 units
period)] [450 – (50x5)] [300 – (50x3)]
c) Maximum Level
[ROL + ROQ – (Min. Consumption x Min Re-order 650 units 750 units
period)] [450 + 300 – (25x4)] [300 + 500 – (25 x
2)]
d) Average Stock Level 425 units 450 units
[Min. Level + Max. Level] / 2 [200 + 650] / 2 (or) [150 + 750] / 2 (or)
or or or
[Min. Level + ½ × ROQ] 350 units 400 units
200 + ½ (300) 150 + ½ (500)
Illustration 13
Anil company buys its annual requirement of 36,000 units in six installments. Each unit costs `1 and the
ordering cost is `25. The inventory carrying cost is estimated at 20% of unit value. Find the total annual
cost of the existing inventory policy. How much money can be saved by using E.O.Q?
Solution:
2.A.O
EOQ =
C
2 × 36,000 ×
=
25
1 × 20%
18,00,000
=
0.2
= 3,000 units

Statement Showing computation of comparative inventory cost of existing policy and proposed EOQ
policy:
Particulars Existing Policy EOQ

(i) Purchase Cost (36000 x 1) 36000 (36000 x 1) 36000
(ii) Ordering Cost [36000/6000 x 25] 150 [36000/3000 x 25] 300
(iii) Carrying Cost [1/2 x 6000 x 1 x 20%] 600 [1/2 x 3000 x 1 x 20%] 300
36,750 36,600
Saving by using EOQ = 36,750 – 36,600 = ` 150
Illustration 14
The annual demand for an item is 3,200 units. The units cost is `6 and inventory carrying charges is 25%
p.a. If the cost of one procurement is `150, determine:
(a) E.O.Q (b) No. of orders per year (c) Time between two consecutive orders.
Solution:
2.A.O
(a) EOQ = C
2 × 3,200 ×
=
150
6 × 25%
9,60,000
=
1.5
= 800 units
(b) No. of orders per year = A / EOQ = 3200 / 800 = 4 orders (A = Annual demand)
(c) Time between two consecutive orders = No. of months in years / No. of orders
= 12/4 = 3 Months
Illustration 15
A company manufactures a special product which requires a component ‘Alpha’. The following
particulars are collected for the year 2015.
1. Annual demand of Alpha 8,000 units

2. Cost of placing an order ` 200 per order
3. Cost per unit of Alpha ` 400
4. Carrying cost % p.a. 20%
The company has been offered a quantity discount of 4% on the purchase of ‘Alpha’ provided the
order size is 4,000 components at a time.
Required:
(a) Compute the economic order quantity.
(b) Advise whether the quantity discount offer can be accepted.

COST ACCOUNTING
Solution:
(a) Calculation of Economic Order Quantity
2AO
EOQ =
C
2 × 8,000 ×
EOQ =
200
400 × 20%
= 200 units
(b) Evaluation of Profitability of Different Options of Order Quantity

(i) When EOQ is ordered
Purchase Cost (8,000 units x ` 400) 32,00,000

Ordering Cost [(8,000 units / 200 units) x ` 200] 8,000
Carrying Cost (200 units x ` 400 x ½ x 20/100 8,000
Total Cost 32,16,000
(ii) When quantity discount is accepted
Purchase Cost (8,000 units x ` 384) 30,72,000

Ordering Cost [(8,000 units / 4000 units) x ` 200] 400
Carrying Cost (4000 units x ` 384 x ½ x 20/100 1,53,600
Advise:
The total cost of inventory is lower if EOQ is adopted. Hence, the company is advised not to accept
the quantity discount.
Illustration 16
From the following particulars with respect to a particular item of materials of a manufacturing
company, calculate the best quantity to order:
Ordering quantities Price per ton

(tonne) Amount (`)
Less than 250 6.00
250 but less than 800 5.90
800 but less than 2,000 5.80
2,000 but less than 4,000 5.70
4,000 and above 5.60
The annual demand for the material is 4,000 tonnes. Stock holding costs are 20% of material cost p.a.
The delivery cost per order is `6.00

Solution:
Statement showing computation of total inventory cost at different order sizes (Annual Demand =
4000 tonnes)
Ordering Quantities
Particulars 200 250 800 2000 4000
(i) Purchasing cost 24000 23600 23200 22800 22400
(4000×6) (4000×5.9) (4000×5.8) (4000×5.7) (4000×5.6)
(ii) No. of orders 20 16 5 2 1
(iii) Ordering Cost (` 6) 120 96 30 12 6
(iv) Average size of order 100 125 400 1000 2000
(v) Inventory Carrying cost per unit 1.2 1.18 1.16 1.14 1.12
(6x20%) (5.9x20%) (5.8x20%) (5.7x20%) (5.6x20%)
(vi) Inventory carrying cost (iv x v) 120 147.5 464 1140 2240
(vii) Total Inventory Cost (iii + i + vi) 24240 23843.5 23694 23952 24646
For the above computations the best quantity to order is 800 units.
Illustration 17
The particulars relating to 1,200 kgs. of a certain raw material purchased by a company during June,
were as follows:-
Lot prices quoted by supplier and accepted by the Company for placing the purchase
order : Lot upto 1,000 kgs. @ `22 per kg.
Between 1,000 - 1,500 kgs, @ `20 per kg.
Between 1500 -2000 kgs. @ `18 per kg.
Trade discount – 20%.
Additional charge for containers @ `10 per drum of 25 kgs.
Credit allowed on return of containers, @ `8 per drum.
GST at 12% on raw material and 5% on drums.
Total fright paid by the purchaser `240/-
Insurance at 2.5% (on net invoice value) paid by the purchaser.
Stores overhead applied at 5% on total purchase cost of material.
The entire quantity was received and issued to production.
The containers are returned in due course. Draw up a suitable statement to show :-
(a) Total cost of material purchased and
(b) Unit cost of material issued to production.

COST ACCOUNTING
Solution:
Statement showing computation of total cost of material purchased and unit cost of material issued
for production. Amount (`)
Particulars Unit Cost Total Cost (1,200 kgs)

Basic price of material 20.00 24,000.00
(-) Trade discount (20%) 4.00 4,800.00
16.00 19,200.00
(+) Drum charges (1,200/25 x 10) 0.40 480.00
(+) GST 19,200 x 12% = 2,304
480 x 5% = 24 1.94 2,328.00
= 2,328
Net Invoice Value 18.34 22,008.00
(+) Insurance (22,008 x 2.5%) 0.4585 550.20
(+) Freight paid 0.2000 240.00
18.9985 22,798.20
(-) Credit for drums returned (1,200 / 25 x 8) 0.3200 384.00
Total Cost of Material Purchased 18.6785 22,414.20
(+) Stores overhead (22,414.20 x 5%) 0.9339 1,120.71
Material cost issued to production 19.6124 23,534.91
Illustration 18
From the following data for the year ended 31st Dec, 2016, calculate the inventory turnover ratio of
the two items, and put forward your comments on them.
Material A Material B
Amount (`) Amount (`)
Opening stock on 1-1-2016 10,000 9,000
Purchase during the year 2016 52,000 27,000
Closing on 31-12-2016 6,000 11,000
Solution:
Material Inventory Turnover Ratio Cost of Material used
= Average Stock
10,000  52,000  6,000

For A =
(10,000  6,000)/ 2
= 7 times
9,000  27,000
For B
11,000
(9,000  11,000)/ 2
=
= 25,000 / 10,000
= 2.5 times
Material Inventory turnover ratio indicates the efficiency of the management with which they are able
to utilize their inventory. It indicates the existence or non-existence of non moving items, dormant items,
slow moving items etc. in inventory. If the ratio is high, the efficiency is said to be high and on the other
hand if the ratio is low, the efficiency is said to be low.
In view of above, in the instant case, we may say that Material A used better than Material B.
Illustration 19
From the details given below, calculate:
(i) Re-ordering level
(ii) Maximum level
(iii) Minimum level
(iv) Danger level
Re-ordering quantity is to be calculated on the basis of following information:

(a) Cost of placing a purchase order is ` 20
(b) Number of units to be purchased during the year is 5,000
(c) Purchase price per unit inclusive of transportation cost is ` 50
(d) Annual cost of storage per units is ` 5
(e) Details of lead time: Average 10 days, Maximum 15 days, Minimum 6 days.
For emergency purchases 4 days
(f) Rate of consumption: Average: 15 units per day,
Maximum: 20 units per day
Solution:
2 × 5,000 ×
EOQ =
20
= 200 units5
Min. Rate of Consumption = (15×2)–20

= 10 units per day
(i) Re-order Level = Maximum usage per period x Maximum Re-order Period
(ROL) = 20 units per day x 15 days = 300 units
(ii) Maximum level = ROL + ROQ – (Min. Rate of Consumption x Min. Re-order Period)
= 300 units + 200 units – (10 units per day x 6 days)
= 440 units
(iii) Minimum level = ROL – (Average Rate of Consumption x Average Re-order Period)
= 300 units – (15 units per day x 10 days)
= 150 units
(iv) Danger level = Average Consumption x Lead time for Emergency Purchases
= 15 units per day x 4 days = 60 units

COST ACCOUNTING
Illustration 20
M/s Tubes Ltd. are the manufacturers of picture tubes for T.V. The following are the details of their
operation during the year 2015:
Average monthly market demand 2,000 Tubes

Ordering Cost `100 per order
Inventory carrying cost 20% per annum
Cost of tubes ` 500 per tube
Normal usage 100 tubes per week
Minimum usage 50 tubes per week
Maximum usage 200 tubes per week
Lead time to supply 6 – 8 weeks
Compute from the above:
(i) Economic order quantity. If the supplier is willing to supply quarterly 1,500 units at a discount of 5%
is it worth accepting?
(ii) Re-order level
(iii) Minimum level of stock
(iv) Maximum level of stock
Solution:
A = Annual usage of tubes = Normal usage per week x 52 weeks
= 100 tubes x 52 weeks = 5,200 tubes
O = Ordering cost per order = ` 100 per order
C = Inventory carrying cost per unit per annum
= 20% x ` 500 = ` 100 per unit, per annum
Economic Order Quantity:
2AO 2 × 5,200 ×
E.O.Q = = = 102 tubes (approx.)
C 100
100
If the supplier is willing to supply 1,500 units at a discount of 5% is it worth accepting?
Total cost (when order size is 1,500 units) = Cost of 5,200 units + Ordering cost + Carrying cost.
 5,200 units 
5,200 units x ` 475 +  ` 100   1,500 units  20% ` 475 2
 1,500 units 
= ` 24,70,000 + ` 346.67 + ` 71,250
= ` 25,41,596.67

Total cost (when order size is 102 units)
 5,200 units 
= 5,200 units × ` 500 +  `100   102 units  20% ` 500 2
 102 units 
= ` 26,00,000 + ` 5,098.03 + ` 5,100 = ` 26,10,198.03
Since the total cost under quarterly supply of 1,500 units with 5% discount is lower than that when order
size is 102 units, the offer should be accepted. While accepting this offer capital blocked on order
size of 1,500 unit per quarter has been ignored.
Re-order Level:
= Maximum Consumption × Maximum Re-order Period
= 200 units × 8 weeks = 1,600 units.
Minimum level of Stock:

= Re-order Level - Normal Usage × Average Re-order Period
= 1,600 units -100 units × 7 weeks = 900 units.
Maximum level of Stock:

= Re-order Level + Re-order Quantity – Min. Usage x Min.-Re-order Period
= 1,600 units + 102 units – 50 units x 6 weeks
= 1,402 units.

COST ACCOUNTING

2.2 EMPLOYEE COSTS (CAS - 7)
Work Study
In order to motivate workers, it is necessary to design a proper incentive system of payment of
wages. Money is the strongest motivating factor and hence monetary incentive system become
essential. In any incentive system, the bonus is paid by comparing the standard
performance/production with the actual performance, i.e. actual production. Bonus is paid if the
actual performance is higher than the standard one. However, for deciding the standard
performance, standard time, i.e. time that is allowed doing a particular job should be fixed against
which the actual time taken should be compared. The Work Study which includes, the Job Study,
and the Method Study ensures the fixation of standard time to do a particular job and thus has
become extremely important in the designing of the incentive system. Work Study components are
discussed below.
Method Study
Method Study is done to improve the methods of production and to achieve the most efficient use of
the resources like, manpower, machines and materials. Method Study has the following stages:-
(a) Method Study is generally conducted for the jobs, which involve complex operations as well as
costly operations. Hence the first step is to select jobs which are having complexity of
operations.
(b) There should be a detailed study of related aspects of the selected job. Information about the
job like, purpose, location, sequence, relationship with other work, methods of working,
operators, requirement of skilled workers, facilities required etc. should be collected.
(c) The crucial step is that after studying the relevant aspects of the job, there should be the
development of an improved method of doing the job.
(d) The developed method should be applied in doing the job.
(e) For any new method, a follow-up is always required. For method study also a constant follow-up
is necessary to ensure that the method selected is implemented properly. Thus, method study
ensures efficient use of resources by reducing unnecessary work and helps to achieve highest
production.
Work Measurement
The Work Measurement aims at determining the effective time required to perform a job. The
ineffective, wasteful or avoidable time is separated from required time to complete the work. The
effective time so established in work measurement can be used for the following purposes: -
(a) Incentive wage schemes which require data about the time allowed and time taken for a particular
job
(b) Improving utilization of men, machines and materials
(c) Assisting in production control
(d) Assisting in setting labour standards
(e) Cost control and reduction

COST ACCOUNTING
The following stages are involved in work measurement:-

(i) Selection of work
(ii) Measuring the actual time taken in the work done
(iii) Making comparison between the standard time and the actual time

Job Evaluation
It is necessary for the management of any organization to establish proper wage and salary
structure for various jobs. For doing this in a scientific manner, it is necessary to determine the
relative value of jobs and hence a job evaluation is done. Job Evaluation is a technique of analysis
and assessment of jobs to determine their relative value within the firm. It aims at providing a
rational and equitable basis for differential salaries and wages for different classes of workers. Job
Evaluation has the following objectives:-
(a) It helps in developing a systematic and rational wage structure as well as job structure.
(b) Job Evaluation aims at removing the controversies and disputes relating to salary between the
employers and employees. Thus the employees and also the employer remain satisfied.
(c) Another important objective of Job Evaluation is to bring fairness and stability in the wage and
salary structure so as to ensure full cooperation of workers in implementing various policies of
the employers.
(d) Job Evaluation discloses characteristics and conditions relating to different jobs. This is very useful at
the time of recruiting of workers as only suitable workers can be recruited. This avoids square
pegs in round holes.
Methods of Job Evaluation
Methods of job evaluation are as follows:-
(1) Point Ranking Method: In this method each job is analyzed in terms of various job factors or
characteristics. The characteristics are skills required, efforts involved, working conditions, hazards,
responsibility and so on. In other words the job factors are the requirements needed for performing
the job effectively. Each job factor is given weightage or points depending upon its value for the job.
For example, for certain jobs, maximum value is assigned to experience while for some jobs,
education may be the most crucial factor. Finally each job is ranked in the order of points or weights
secured by them. The wage structure can be suitably designed according to the points assigned to
each job. The method is quite sound in principle but difficulties may be faced assigning the weights
to each job.
(2) Ranking Method: In this method, jobs are ranked in order of importance on the basis of skills
required, experience requirements, working conditions etc. Jobs are rearranged in an order, which
can be either from the lowest to the highest or in the reverse. Wage scales are determined in terms
of ranks. Though this method is quite simple to operate and less costly as well as easy for
understanding, it is suitable when the size of the organization is small and jobs are few and well
defined. In a large organization, where jobs are quite complex, this method is not beneficial.
(3) Grading Method: This method is an improvement over the ranking method. Under this method,
each job is analyzed in terms of a predetermined grade and then assigned a grade or class. Grades
are established after making an investigation of job factors, such as complexity in the job,
supervision, responsibility, education etc.
Merit Rating
Job Evaluation is the rating of the job in order to bring rationality in the wage and salary structure in
the organization. On the other hand Merit Rating is the comparative evaluation and analysis of
individual merits of the employees. The Merit Rating aims at evaluation and ranking the individual
employees in order to plan and implement rational promotional policies in the organization. Merit
Rating has the following objectives:-
(a) To evaluate the merit of an employee for the purpose of promotion, increment, reward and
other benefits
(b) To establish and develop a wage system and incentive scheme

COST ACCOUNTING
(c) To determine the suitability of an employee for a particular job

(d) To analyze the merits or limitations of a worker and help him to develop his capability and
competence for a job
(e) To examine characteristics like cooperation, quality of work done, attendance and regularity,
education, skill, experience, character and integrity and initiative
Thus it can be understood that Merit Rating is extremely useful for organizations for evaluating the
employees. However the main limitations are that the rating can be subjective which will give rise to
the disputes and there is a possibility that past performance of an employee may be given too much
importance.
Difference between Merit Rating and Job Evaluation

The difference between the Merit Rating and Job Evaluation are as follows:-
(a) Job Evaluation is the assessment of the relative worth of jobs within a business enterprise and Merit
Rating is the assessment of the employees with respect to a job.
(b) Job Evaluation helps in establishing a rational wage and salary structure. On the other hand,
Merit Rating helps in fixing fair wages for each worker in terms of his competence and
performance.
(c) Job Evaluation brings uniformity in wages and salaries while Merit Rating aims at providing a
fair rate of pay for different workers on the basis of their performance.
Time and Motion Study

The study of time and motion is essential for designing an incentive system. Time Study determines
the time to be spent on the job. Standard time is the time that should be taken for completing a
particular job under standard or normal working conditions. For fixation of standard time, Motion
Study is necessary. Thus, the Motion Study precedes the Time Study. Motion Study means dividing the
job into fundamental elements or basic operations of the job or process and studying them in detail
to eliminate the unnecessary elements or motions. After investigation all movements in a job,
process or operation, the Motion Study aims at finding out the most scientific and systematic way of
performing the job. After eliminating unnecessary motions, the time that should be taken to perform
these motions is decided with the help of a stop-watch. In the time so fixed, some allowance is
added in the same for normal idle time, which is due to fatigue, change of job, change of tools, and
preventive maintenance of machines and so on. Thus standard time for a job or process is arrived at.
The Time and Motion Study aims at :-
(a) Eliminating unnecessary motions, thereby reducing inefficiency
(b) Improving methods, procedures, techniques, and processes relating to a job
(c) Effective utilization of men, material, machines and time
(d) Improving working environment, layout and design of plant and equipment
The following are the benefits of Time and Motion Study:-

(a) Effective utilization of resources like men, material, machine and time
(b) Helps in assessment of labour
(c) Helps in designing incentive system as many of the incentive systems are based on standard time
(d) Preparation of labour budget
(e) Proper planning of production for preparation of production budget
(f) Helps in improving labour productivity by designing best method for performing a job or process

COST ACCOUNTING
(g) Improvement of work methods

COST ACCOUNTING
Idle Time
Idle Time Cost represents the wages paid for the time lost during which the worker does not work, i.e
time for which wages are paid, but no work is done. As per CAS-7 (Limited Revision 2017), Idle Time is
‘The difference between the time for which the employees are paid/payable to employees and
the employees time booked against the cost object’. This happens because due to various causes
for which he is not responsible, the worker remains idle but full wages are paid to him. Even for workers
who are paid on the basis of output, idle time payment may be required to be made.
The causes leading to idle time may be broadly classified into four categories, viz. :-
(i) Normal, inherent or unavoidable idle time: Time lost between the gate and place of work, break
for tea, time interval between one job and another, time for tool setting, adjustment of
machine, etc.
(ii) Normal idle time such as waits for jobs, tools, materials or instructions, small power failures, small
breakdown of machines and tools, and atmospheric conditions
(iii) Abnormal idle time such as those arising due to breakdown for considerable period, non-
availability of raw materials, slack supervision, strikes or lock-outs, fire flood, storm, etc.
(iv) Concealed idle time such as manipulation of job breaking, wastage of time due to under-
employment, i.e., unnecessary work like cleaning, grass cutting and gardening to employ idle
men, and employment of skilled workers on unskilled jobs
Idle time should not be booked directly to jobs or production orders because such a practice not
only increases the cost of direct labour, but also vitiates comparison of idle time costs from time to
time. In booking of time, idle or waiting time should not normally record in the job card but on
separate idle time cards. Separate cards or registers may be provided for recording idle time
according to the causes which give rise to it.

Methods of Wage Payment
One of the important components of Labour Cost Control is the wages system. A system of wage
payment, which takes care of both, i.e. providing guarantee of minimum wages as well as offering
incentive to efficient workers helps to motivate the workers to a great extent. It should also be
remembered that high wages do not necessarily mean high labour cost because it may be observed
that due to high wages the productivity of workers is also high and hence the per unit cost of
production is actually decreased. On the other hand, if low wages are paid, it may result in lower
productivity and hence higher wages do not necessarily mean high cost.
The following are the various methods of payment of wages.
A. Time Rate System
(a) At ordinary levels
(b) At high wage levels and
(c) Graduated Time Rate

COST ACCOUNTING
B. Piece Rate
(a) Straight Piece Rate
(b) Piece Rate with Guaranteed Day Rates and
(c) Differential Piece Rates
C. Bonus Systems
(a) Individual Bonus for Direct Workers
(b) Group Bonus for Direct Workers and
(c) Bonus for Indirect Workers
D. Indirect Monetary Incentives

(a) Profit Sharing and
(b) Co-partnerships
E. Non-monetary incentives like job security, social and general welfare, sports, medical facilities etc.
These methods are discussed in the following paragraphs:
A. Time Rate Method
Time Rate at Ordinary Levels

Under this method, rate of payment of wages per hour is fixed and payment is made accordingly on the
basis of time worked irrespective of the output produced. However, overtime is paid as per the statutory
provisions. The main benefit of this method for the workers is that they get guarantee of minimum
income irrespective of the output produced by them. If a worker is not able to work due to genuine
reasons like illness or physical disability, he will continue to get the wages on the basis of time taken for a
particular job. This method is used in the following situation:-
(a) Where the work requires high skill and quality is more important than the quantity.
(b) Where the output/services is not quantifiable, i.e. where the output/services cannot be measured.
(c) Where the work done by one person is dependent upon other person, in other words where a
individual worker has no control over the work.
(d) Where the speed of production is governed by time in process or speed of a machine.
(e) Where the workers are learners or inexperienced.
(f) Where continuous supervision is not possible.
The main advantage of this method is that the worker is assured of minimum income irrespective of
the output produced. He can focus on quality as there is no monetary incentive for producing more
output. However, the main limitation of this method is that it does not offer any incentive to the
efficient workers. Efficient and inefficient workers are paid at the same rate of wages and hence
there is a possibility that even an efficient worker may become inefficient due to lack of incentive.
Time Rate at High Wage Levels

This system is a variation of time rate at ordinary levels in the sense that in this system, workers are paid
at time rate but the rate is much higher than that is normally paid in the industry or area. In this
method, the workers are paid according to the time taken and overtime is not normally allowed. This
method offers a very strong incentive to workers and it can attract talented workers in the industry.
However, care should be taken that productivity also increases; otherwise the cost will go on
increasing.
Graduated Time Rate
Under this method payment is made at time rate, which varies according to personal qualities of the
workers. The rate also changes with the official cost of living index.

COST ACCOUNTING
Graduated Time Rate

Under this method payment is made at a time rate, which varies according to the personal qualities
of the workers. The rate also changes with the official cost of living index. Thus, this method is
suitable for both employer and employees.
B. Piece Rate Method
This method is also called payment by results where the workers are paid as per the production
achieved by them. Thus, if a worker produces higher output, he can earn higher wages.
Under the piece rate system of wage payment, the workers receive a flat rate of wages either for
time worked or for units manufactured.
The advantages of such a system are summarized below:-
(a) As the workers are paid on the basis of the results, i.e., for each unit produced, job performed
or number of operations completed, there is a tendency on their part to increase their
production so that they may earn more wages.
(b) The increased production thus achieved results in the reduction of overhead expenses per unit
of production even though total overheads may increase. The increase in overheads will be
relatively small compared to the increase in turnover.
(c) The wages being paid on the basis of production, the management know the labor cost per unit
or per job.
(d) The workers are rewarded for their efficiency because the inefficient workers will not get as
much as the efficient workers.
(e) The workers are very careful in handling their tools and machinery, etc., because the proper
maintenance of these depends on their higher efficiency and in turn, their higher wages.
(f) This method is very simple to operate.
The Disadvantages on the other hand are as follows: -

(a) It is not easy to determine the piece work rate on an equitable basis. When a rate has been
fixed and later on it is found to be too high, it is very difficult to reduce it as its reduction will
cause dissatisfaction and friction among the workers.
(b) As the labor cost per unit remains the same, the employees do not gain as a result of increase
in productivity except to some extent in the form of reduction in overheads. As such if the
overhead expenses per unit are relatively small, the advantage to the employer will not be
significant.
(c) Sometimes quantity may increase at the cost of quality. For this reason, a strict inspection has
to be maintained in the form of quality control. This will result in additional expenditure.
(d) Materials may be used in excessive quantities and may be handed carelessly on account of
the workers’ efforts to achieve high output.
(e) This method may cause discontent amongst those who are slow and those who are paid on a
time basis.
(f) The workers may to increase production, handle the machines carelessly causing major
damage or breakdown.

The following are the variations of this method.
Straight Piece Rate

In this method, rate per unit is fixed and the worker is paid according to this rate. For example, if the
rate per unit is fixed at `10, and the output produced is 300 units, the remuneration to the worker will be
`10 X 300 units = `3, 000. This method thus offers a very strong incentive to the workers and is
particularly suitable where the work is repetitive. The benefits of this method are as follows:-
(a) The method is simple and provides a very strong incentive to the workers by linking the
monetary reward directly to the results.

COST ACCOUNTING
(b) Productivity can be increased substantially if the rate of pay includes a really adequate incentive.
(c) Higher productivity will result in lowering the cost per unit.
However, the main limitation of this method is that if a worker is not able to work efficiently due to
reasons beyond his control, he will be penalized in the form of lower wages.
Differential Piece Rates
Under these methods, the rate per standard hour of production is increased as the output level rises.
The increase in rates may be proportionate to the increase in output or proportionately more or less
than that as may be decided. In other words, a worker is paid higher wages for higher productivity
as an incentive. The rate per unit will be higher in this case as compared to the rate paid to a
worker with lower productivity. For deciding the efficiency, comparison is made between the
standard production and actual production of the worker. If the actual production is more, the
worker qualifies for higher rate of wages. The Differential Piece Rate methods will be useful when
the production is of repetitive type, methods of production are standardized and the output can be
identified with individual workers. The following are the major systems of differential piece rate
system:-
(i) Taylor (ii) Merrick (iii) Gantt Task and Bonus
Taylor’s Differential Piece Rate System
Taylor is regarded as father of scientific management and he has recommended a system of
Differential Piece Rate. According to him, there are only two classes of workers, efficient and
inefficient. He suggests that while efficient workers should be encouraged to the maximum possible
extent, the inefficient workers should be penalized. In order to do this, he has suggested two rates for
the two classes of workers. Thus according to Taylor, if the workers are efficient, they should be paid
@ 120% of the normal piece rate and if they are inefficient, they should be paid @ 80% of the
normal piece rate. For measuring efficiency, each worker will be given a standard production
quantity to be produced in the time allowed and the actual production should be compared with
the same. If a worker exceeds the standard, he will be regarded as efficient while if he fails to do so,
he will be regarded as inefficient. The positive and negative points of this system are as follows:-
Merits:-
(a) There is a very strong incentive to the workers, which helps to achieve higher productivity.
(b) Due to the incentive, best workers are attracted to the company.
(c) This method is quite simple and hence easy to understand.
Limitations:
(a) Slow workers and beginners are penalized severely. Similarly workers get penalized for reasons
beyond their control, e.g. medical reasons, accidents etc. Therefore it is said that there is no
human element in this system.
(b) In an anxiety to produce more, quality may be neglected in order to achieve higher quantity
of production.

Illustration 1
From the following particulars, calculate the earnings of workers X and Y and also comment on the
labour cost.
Standard time allowed: 20 units per hour
Normal time rate: `30 per hour
Differential Rate to be applied:
80% of piece rate when below standard

COST ACCOUNTING
120% of piece rate at or above standard

In a particular day of 8 hours, X produces 140 units while Y produces 165 units.
Solution:
Standard production per day is 20 units × 8 hours = 160 units
Worker ‘X’ produces 140 units which means he is below standard and will get wages @ 80% of the
normal piece rate.
X’s earnings:
Normal piece rate = `30 per hour/20 units = `1.5 per unit
80% of the normal piece rate = `1.20 per unit
Earnings = `1.20 × 140 units = `168
Labour cost per unit = `168/140 units = `1.20
Y’s Earnings:
Y has produced more than the standard production of 160 units and hence he will
get wages @ 120% of normal piece rate. His earnings will be as shown below.
Normal piece rate = `30 per hour/20 units = `1.50 per unit
120% of normal piece rate = `1.80 per unit
Earnings = `1.80 ×165 units = `297
Labour cost per unit = `2.97/165 units = `1.80
Comment: Labour cost increases from `1.20 per unit to `1.80 per unit. Taylor’s system is resisted on
this ground as well as on the ground that it is very harsh on the workers.
Merrick Differential Piece Rate System
Merrick’s system is modification of Taylor’s system and is comparatively less harsh on the workers.
The scale of remunerations is as follows:-
Production Rates of Payment
Up to 83% of production - Normal piece rate
83% to 100% of production - 110% of ordinary piece rate
Above 100% of production - 120% of ordinary piece
rate
As mentioned earlier, this method is less harsh on the workers as compared to Taylor’s system. It is
particularly useful to beginners and also offers an incentive who have potential of higher
productivity.

Gantt Task Bonus Plan
In this method, there is a combination of time rate, bonus and piece rate plan. The remuneration is
computed as shown below:
Production below standard - Guaranteed time rate
Production at standard - Bonus of 20% [normally] of time rate
Production above standard - High piece rate for the entire output
This method assures minimum wages for even too less efficient workers and hence is a preferred method
of payment of wages. It also offers reasonably good incentive to efficient workers. However, the main

COST ACCOUNTING
limitation is that the method is complicated to understand by the workers and hence may create
confusion amongst them.
Illustration 2
X, Y and Z are three workers working in a manufacturing company and their output during a
particular 40 hours week was 96, 111 and 126 units respectively. The guaranteed rate per hour is `10
per hour, low piece rate is `4 per unit, and high piece rate is `6 per unit. High task is 100 units per
week. Compute the total earnings and labour cost per unit under Taylor, Merrick and Gantt Task
Bonus Plan.
Solution:
(a) Taylor Plan:
High task is 100 units
Worker X = Actual output is 96 units, which is less than the standard. This means he is inefficient
and will get 80% of the normal piece rate i.e. @ `4.80 per unit. His wages will be = `4.80 ×96 units
=
`460.80.
Worker Y = Actual output is 111 units which is more than the standard. This means he is efficient
and will get 120% of the normal piece rate i.e. `7.20 per unit. His wages will be = `7.20 × 111 units
=
`799.20
Worker Z = Actual output is 126 units, more than the standard. This means his wages will be = `7.20
×126 units = `907.20.
(b) Merrick Plan:
Worker X = High task is 100 units, actual output is 96, this means that the efficiency level is 96%.
As per Merrick Plan, wages of X will be 110% of normal piece rate which is `6.60 per unit = `6.60 ×
96 units = `633.6
Worker Y = High task is 100 units, actual output is 111 units, efficiency level is 111%. Y will be
entitled for wages @ 120% of normal piece rate i.e. @ `7.20 per unit. His wages will be, `7.20 ×
111 units =
`799.2
Worker Z = High task is 100 units, actual output is 126 units, efficiency level is 126%. Z will get at
higher piece rate @ `7.20 per unit. His wages will be `7.20 × 126 units = `907.2
(c) Gantt Task and Bonus Plan:
Worker X = `10 × 40 hours = `400 [X will get guaranteed time rate as his output is below the high
task]
Worker Y = `6 × 111 units = `666 [High piece rate as output is above standard]
Worker Z = `6 × `126 units = `756 [High piece rate as output is above standard]
Emerson’s Efficiency System

Under this system minimum time wages are guaranteed. Bonus in addition to minimum day wages
is given to the worker beyond a certain efficiency level. A worker who is able to attain efficiency
measured by his output which is equal to 2/3rd of this standard efficiency or above, is deemed to be
an efficient worker who deserves encouragement.
The scheme provides for payment of bonus at various levels of efficiency ranging from 66.67% to 150%
in the following manner:
(i) for a performance below 66.67% efficiency, only time rate wages is paid without any bonus
(ii) for a performance between 66.67% and 100% efficiency, bonus varies between 0.01% and 20%

COST ACCOUNTING
(iii) above 100% efficiency level, bonus of 20% of basic wages + 1% for each 1% increase in efficiency
is admissible
Emerson’s Efficiency System is superior to other differential piece rate as it encourages the slow
worker to do better than before. It does not pre−suppose a high degree of average performance.
The wages are guaranteed on time basis.
Points Scheme−Bedaux System
Under this system the quantum of work that can be performed by a worker is expressed in Bedaux
Points or B’s. These points represent the standard time expressed in terms of minutes that are necessary
to perform a job. The standard numbers of points in terms of minutes are determined after
analysing each operation or job in detail. Each such minute consists of the time required to complete
a fraction of the operation or the job and also an allowance for rest due to fatigue. The workers
who are not able to complete the tasks allotted to them within the standard time are paid only the
normal daily rate of wages. Those workers who are able to increase their efficiency rate which is
equal to the wages for time saved as indicated by excess of B’s earned (i.e. standard time for work
done − over actual time) are paid 75% of the time saved.
Individual Bonus Plans

We have seen earlier that in the time rate system, the workers are paid according to the time taken
while in case of piece rate system, the output produced by the worker decides his wages as rate per
unit is fixed rather than rate per hour. In the premium bonus plan, the gain arising out of increased
productivity is shared by both, the employer and employee.
The bonus to be paid to the workers is computed on the basis of savings in the hours, i.e. the
difference between the time allowed and time taken. The time allowed is the standard time, which is
fixed by conducting a time and motion study by the work-study engineers. While fixing the standard
time, due allowance is given for physical and mental fatigue as well as for normal idle time. The
actual time taken is compared with this standard time and bonus is payable to the worker if the time
taken is less than the standard time.
The individual bonus schemes commonly used are as follows.
(a) Halsey Premium Plan
(b) Halsey-Weir Premium Plan
(c) Rowan Plan
(d) Barth Variable Sharing Plan
These methods are discussed
below:-
(a) Halsey Premium Plan

This plan was introduced by F.A. Halsey, an American engineer. In this plan, bonus is paid on the
basis of time saved. Standard time is fixed for a job and if the actual time taken is less than the
same, the worker becomes eligible for bonus. However bonus is paid equal to wages of 50% of the
time saved. A worker is assured of time wages if he takes longer time than the allowed time. The
formula for computing the total wages is as follows.
Total Earnings = H X R + 50% [S – H] R
Where, H = Hours worked, R = Rate per hour, S = Standard time
Illustration 3
Time allowed for a job is 48 hours; a worker takes 40 hours to complete the job. Time rate per hour is
`15. Compute the total earnings of the worker.

COST ACCOUNTING
Solution:
Total Earnings = H X R + 50% [S – H] R
Total Earnings = 40 X `15 + 50% [48 – 40] `15
Total Earnings = `600 + `60 = `660
(b) Halsey – Weir Plan

Under this method, there is only one difference as compared to the Halsey Plan and that is instead of
50% bonus for the time saved, it is 3331 rd % of the time saved. Accordingly the formula for this method
is modified as follows.
Total Earnings = H × R + 3331 [S-H]R
H = Hours worked. R = Rate per hour, S = Standard time
(c) Rowan Plan

This premium bonus plan was introduced by Mr. James Rowan. It is similar to that of Halsey Plan in
respect of time saved, but bonus hours are calculated as the proportion of the time taken which the
time saved bears to the time allowed and they are paid for at time rate. The formula for
computation of total earnings is as follows:-
Total Earnings = H × R + [S – H]/S × H × R
Where H = Hours worked, R = Rate per hour, S = Standard time,
(d) Barth Variable Sharing Plan:
In this system, the total earnings are calculated as follows:
Total Earnings = R  SH
H = Hours worked, R = Rate per hour, S = Standard time.
Group Bonus Plan
The plans described above are all individual bonus plans. Many times output of individuals cannot be
measured. Similarly, the output of individual is dependent on the performance of the group. In such
cases, rather than implementing individual bonus systems, group bonus system is implemented. The
total amount of bonus, which is determined according to productivity, can then be shared equally or
in agreed proportion between the group members. The main objects of group bonus system are as
follows:-
(a) Creation of team spirit
(b) Elimination of excessive waste of materials and time
(c) Recognition of group efforts
(d) Improving productivity
Different Group Bonus Schemes in use are as follows:-
(i) Budgeted Expenses Bonus: Under this system, bonus is based on the savings in actual total
expenditure compared with the budgeted expenditure.
(ii) Cost Efficiency Bonus: In this method, standards are set for expenses like material, labour and
overheads. The actual expenditure against these standards is measured and if there is a savings in
actual expenditure as compared to the standards, a portion of such savings is distributed as bonus
amongst the workers.
(iii) Pristman System: In this method, production standards are set in units or points and actual
production is compared with the standards. If the actual production exceeds the standard, the
workers are paid additional wages equal to the percentage of output over standard. Obviously
no bonus is

COST ACCOUNTING
payable if actual production does not exceed the standard production. This method is mainly
used in foundries.
(iv) Towne Profit Sharing Plan: In this method standards are set for costs [mainly labour cost] and the
actual cost is compared with the standards. If there is a saving in the costs, the saving is shared
by workers and supervisory staff in agreed proportion. The principle behind this method is that if
there is a saving in the cost, not only the workers but the supervisory staff should also get the
reward because the cost reduction is the joint efforts of both the types of staff. Hence both,
workers and supervisors share it.
(v) Waste Reduction Bonus: This system of bonus is based on savings in the material cost. If there is
a saving in the material cost, the workers share the same in the agreed proportion. This system is
generally used in industries where cost of material is very high.
(vi) Rucker Plan: The amount of bonus is linked with ‘value added’ in this system. The ‘value
added’ is obtained by deducting the cost of material and services from sales value. In other
words, value added is the total of labour, overheads and profits. Under this plan, employees
receive a constant proportion of value added. For example, if the target ratio of labour cost to
value added is 70%, and the actual ratio comes to 68%, 2% of the actual value added is
distributed as group bonus, so that the ratio of direct labour cost to value added is maintained
at 70%. Normally instead of distributing the entire bonus, some proportion is distributed and the
remaining is transferred to reserve fund.
(vii) Scanlon Plan: This method is similar to the Rucker plan as discussed above except that the
ratio of labour cost to the sales is taken instead of direct labour cost to added value. Normally
bonus is paid based on average of last three years ratios. A part of the bonus may be
transferred to bonus equalization fund for future use when the workers do not get bonus under
this scheme.
Bonus System for Indirect Workers
Indirect workers do not take part in the production process directly but they play important role in the
production process. It is difficult to chalk out a bonus system for indirect workers, as there is a difficulty
in measuring their output. However it is advisable to plan a bonus system for indirect workers in order
to motivate them for better productivity. Bonus to indirect workers is paid on the basis of output of the
department, saving in time or expenditure against the budgeted, product quality, reduction of waste
and scrap and reduction of labour turnover.
Indirect Monetary Incentives
These methods aim at giving additional remuneration based on the prosperity of the concern. The
following schemes fall in this category:-
(a) Profit Sharing: In this system, the profits of the organization are shared by workers in agreed
proportion. The Payment of Bonus Act 1965 in India makes it mandatory to pay minimum bonus of
8.33% of salary and maximum bonus of 20% of salary to the workers.
(b) Co-partnership: In this system, the workers get an opportunity to participate in the ownership of
the organization and to receive the part of share of profits. The employees are given assistance
to purchase shares of the company. Thus the employees get dividend and bonus also. These
schemes help to boost the morale of workers to a great extent.
Non-Monetary Incentives
These incentives are given in addition to monetary incentives for further boosting the moral of the
employees. Though these benefits do not result in additional remuneration, they help to improve
productivity by boosting the morale of the employees.
Some of the non-monetary incentives are as follows:-
(a) Free education and training
(b) Medical benefits

COST ACCOUNTING
(c) Subsidized canteens

(d) Superannuation benefits like pensions, gratuity, life assurance schemes etc
(e) Sports and recreation facilities, housing facilities, long service awards
(f) Job security, promotion schemes
(g) Benevolent funds and welfare funds

Labour Turnover
Labour Turnover of an organisation is change in the labour force during a specified period measured
against a suitable index. The rate of Labour Turnover in an industry depends upon several factors
such as, nature of the industry, its size, location and composition of the labour force. A controlled
level of Labour Turnover is considered desirable because it helps the firm to adjust the size of its
labour force in response to needs such as for seasonal changes or changes in technology.
Causes of Labour Turnovers

The causes giving rise to high labour turnover may be broadly classified under the following the heads:
(i) Personnel Causes: Workers may leave employment purely on personal grounds, e.g.,
(a) Dislike for the job, locality or environments

COST ACCOUNTING
(b) Domestic troubles and family responsibilities

(c) Change of line for betterment
(d) Retirement due to old age and ill health
(e) Death
In all such cases, personal factors count the most and employer can practically do nothing to help
the situation.
(ii) Unavoidable Causes : In certain circumstances it becomes obligatory on the part of the
management to ask some of the workers to leave. These circumstances are:
(a) Retrenchment due to seasonal trade, shortage of any material and other resources, slack
market for the product, etc.
(b) Discharge on disciplinary grounds
(c) Discharge due to continued or long absence
(iii) Avoidable Causes: Under this head, may be grouped the causes which need the attention of
the management most so that the turnover may be kept low by taking remedial measures. The
main reasons for which workers leave are:
(a) Unsuitability of job
(b) Low pay and allowance
(c) Unsatisfactory working conditions
(d) Unhappy relations with co-workers and unsatisfactory behaviour of superiors
(e) Dispute between rival trade unions
(f) Lack of transport, accommodation, medical and other factors
(g) Lack of amenities like recreational centres, schools, etc.
The above causes may also be classified in a different manner under three heads, viz., Financial
Causes, Social and Economic Causes and Psychological Causes relating to human relationship.
Measurement of Labour Turnover

It is essential for any organisation to measure the Labour Turnover. This is necessary for having an idea
about the turnover in the organisation and also to compare the Labour Turnover of the previous period
with the current one. The following methods are available for measurement of the Labour Turnover:-
(a) Additions Method: Under this method, number of employees added during a particular period is
taken into consideration for computing the Labour Turnover. The method of computing is as follows.
Labour Turnover = (Number of additions/Average number of workers during the period) ×100
(b) Separation Method: In this method, instead of taking the number of employees added, number
of employees left during the period is taken into consideration. The method of computation is as
follows.
Labour Turnover = Number of separations/Average number of workers during the period)×100
(c) Replacement Method: In this method neither the additions nor the separations are taken into
consideration. The number of employees replaced is taken into consideration for computing the
Labour turnover.
Labour Turnover = (Number of replacements/Average number of workers during the period)×100

(d) Flux Method: Under this method Labour Turnover is computed by taking into consideration
the additions as well as separations. The turnover can also be computed by taking replacements
and separations also. Computation is done as per the following methods.
Labour Turnover = ½ [Number of additions + Number of separations] /Average number of workers
during the period ×100
Labour Turnover = ½ [Number of replacements + Number of separations] /Average number of
workers during the period × 100

COST ACCOUNTING
Illustration 4
During October 2015, the following information is obtained from the Personnel Department of a
manufacturing company. Labour force at the beginning of the month 1900 and at the end of the
month 2100. During the month, 25 people left while 40 persons were discharged. 280 workers were
engaged out of which only 30 were appointed in the vacancy created by the number of workers
separated and the rest on account of expansion scheme. Calculate the Labour Turnover by different
methods.
Solution:
Computation of Labour Turnover
Additions Method:
Number of Additions/Number of average workers during the period = 280 / 2000 X 100 = 14%
Separation Method:
Number of Separations/Number of average workers during the period = (25+40)/2000 × 100 = 3.25%
Replacement Method:
Number of Replacements / Number of average workers during the period = 30/2000 X 100 = 1.5%

Flux Method:
½ [Number of Additions + Number of Separations] / Number of average workers during the period
= [½(280 + 65) / 2000]×100 = 173/2000 X 100 = 8.63%
Note: Average number of workers in all the above methods is computed by taking Opening number of
workers + Closing number of workers / 2 = 1900 + 2100/2 =2000
Illustration 5
The management of XYZ Ltd. is worried about the increasing Labour Turnover in the factory and
before analyzing the causes and taking remedial steps; they want to have an idea of the profit
foregone as a result of Labour Turnover during the last year. Last year’s sales amounted to `83, 03,300
and the profit/ volume ratio was 20%. The total number of actual hours worked by the direct Labour
force was 4.45 lakhs. As a result of the delays by the Personnel department in filling vacancies due
to Labour Turnover, 1,00,000 potentially productive hours were lost. The Actual Direct Labour hours
included 30, 000 hours attributable to training new recruits, out of which, half of the hours were
unproductive. The cost incurred consequent on Labour turnover revealed, on analysis the following.
Settlement cost due to leaving: `43, 820 & Recruitment costs: `26,740. Selection costs: `12,750, &
Training costs: `30,490
Assuming that the potential production lost as a consequence of Labour Turnover could have
been sold at prevailing prices, find the profit foregone last year on account of Labour Turnover.
Solution:
We will have to calculate the profit foregone by calculating the amount of contribution lost and the
additional cost that was incurred as a result of the Labour Turnover. This is done in the following manner.
I. Actual productive hours: Actual hours worked – Unproductive training hours
= 4,45,000 – 15,000 [50% of 30, 000]
= 4,30,000 actual productive hours.
II. Total hours lost: 1,00,000 hrs

Sales lost [` 83,03,300 × 1,00,000]/4,30,000 = `19,31,000
Loss of contribution – 20% of `19,31,000 = `3,86,200
Statement Showing Profit Foregone
Amount (`)
Contribution lost: 3,86,200
Settlement cost due to leaving: 43,820
Recruitment cost: 26,740
Selection cost: 12,750
Training cost: 30,490
Profit foregone: 5,00,000
Illustration 6
Calculate the total earnings and effective rate of earnings per hour of three operators under Rowan
System and Halsey System from the following particulars.
The standard time fixed for producing 1 dozen articles is 50 hours. The rate of wages is `1/- per hour.
The actual time taken by three are as follows:-
A 45 hours
B 40 hours
C 30 hours.
COST ACCOUNTING
Solution:
Computation of Total Earnings of workers under Halsey Plan
Earnings under Halsey Plan = Hours worked × Rate per hour + (50% × Time saved × Rate per hour)
Worker Earnings Effective Rate
A E = (45 x 1) + 50/100 (50-45) x 1 Effective Rate = 47.5/45
= 47.5 = 1.06
B E = (40 x 1) + 50/100 (50-40) x 1 Effective Rate = 45/40
= 45 = 1.125
C E = (30 x 1) + 50/100 (50-30) x 1 Effective Rate = 40/30
= 40 = 1.33
Computation of Total Earnings of workers under Rowan Plan

Earnings under Rowan Plan =
Time saved
Hours worked × Rate per hour + (
Time allowed × Hours worked × Rate per hour)
Earnings Effective Rate
A E = (45 x 1) + [50-45 / 50] 45 x 1 Effective Rate = 49.5/45
= 45 + 4.5 = 1.1
= 49.5
B E = (40 x 1) + [50-40 / 50] 40 x 1 Effective Rate = 48/40
= 40 + 8 = 1.2
= 48
C E = (30 x 1) + [50-30 / 50] 30 x 1 Effective Rate = 42/30
= 30 + 12 = 1.4
= 42
Illustration 7
A workman takes 9 hours to complete a job on daily wages and 6 hours on a scheme of payment by
results. His hourly rate is 25 p. The Material cost of the product is `4 and factory overheads are
recovered at 150% of the total direct wages. Calculate the factory cost of the product under
following methods:-
(a) Time rate system (b) Halsey Plan (c) Rowan Plan.
Solution:
Computation of factory cost under three systems: Amount (`)
Time Rate System Halsey Plan Rowan Plan

Material 4.00 4.00 4.00
Labour (working notes) 2.25 1.88 2.00
Overheads (150% of total direct wages) 3.38 2.82 3.00
Factory Cost 9.63 8.70 9.00
Working Notes: Amount (`)
Time Rate System Halsey Plan Rowan Plan

Labour 9 x 0.25 6 x 0.25 + 1/2 (9-6) x 6 x 0.25 + (9-6 / 9) x 6 x
0.25 0.25

2.25 1.88 2.00

COST ACCOUNTING
Illustration 8
A worker under the Halsey method of remuneration has a day rate of `12 per week of 48 hours,
plus a cost of living bonus of 10 p. per hour worked. He is given 8 hours task to perform, which he
performs in 6 hours, he is allowed 30% of the time saved as premium bonus. What would be his
earnings under Halsey Plan and Rowan Plan.
Solution:
Computation of earnings of worker under Halsey Plan:
Earnings under Halsey Plan = Hours worked × Rate per hour + (30% × Time Saved × Rate per hour)
= (6 x 0.25) + 30/100 (8-6) x 0.25 = 1.65
(+) Cost of Living Bonus (6 x 0.1) = 0.60
Earnings under Halsey Plan = `2.25
Computation of earnings of worker under Rowan Plan:

Earnings under Rowan Plan =
Time saved
Hours worked × Rate per hour + (
Time allowed × Hours worked × Rate per hour)
= (6 × 0.25) + (8-6 / 8) × 6 × 0.25 = 1.88
(+) Cost of Living Bonus (6 × 0.1) = 0.60
= `2.48
Earnings under Halsey Plan = ` 2.25
Earnings under Rowan Plan = ` 2.48
Illustration 9
In a factory guaranteed wages at the rate of ` 1.80 per hour are paid in a 48 hour week. By time
and motion study it is estimated that to manufacture one unit of a particular product 20 minutes are
taken, the time allowed is increased by 25% . During the week A produced 180 units of the product.
Calculate his wages under the following methods:
(a) Time Rate
(b) Piece Rate with a guaranteed weekly wage
(c) Halsey premium Bonus
(d) Rowan Premium Bonus
Solution:
(a) Calculation of wages under Time Rate System
Earnings under time wages = TR
= 48 × 1.8 = ` 86.4
(b) Calculation of wages under Piece Rate with a Guaranteed Wage Rate
Normal Time for one unit = 20 minutes
(+) Relaxation allowance @ 25% = 5 minutes
Standard Time = 25 minutes

No. of pieces per hour = 60/25 pieces.
Piece Rate = Hourly Rate / No. of pieces per
hour
= 1.8 ÷ (60/25)
= 0.75
Earnings under Piece Rate = 180 x 0.75 = ` 135
(c) Calculation of wages under Halsey Premium Bonus
Standard time for actual production = 180 x 25 / 60 = 75 hours
Earnings under Halsey Plan =
= (48 x 1.8) + 50/100 (75-48) x 1.8
= 86.4 + 24.3 = ` 110.70
(d) Calculation of wages under Rowan Premium Bonus
Standard time for actual production = 180 x 25 / 60 = 75
hours Earnings under Rowan Plan = (48 x 1.8) + (75-48 / 75) x (48 x 1.8)
= 86.4 + 31.104 = ` 117.50
Illustration 10
Calculate the earnings of workers A and B under Straight Piece Rate system and Taylor’s Differential
Piece Rate system from the following particulars:-
Normal rate per hour - `1.80
Standard time per unit 20 seconds
Differentials to be applies are:
80% of the piece rate below the standard;
120% of the piece rate at or above standard.
A produced 1,300 units per day of 8 hours & B -1,500 units per day of 8 hours.
Solution:
Pieces per minute = 60/20 = 3 units
Units per hour = 60 x 3 = 180
units Normal piece rate = 1.8 /180 = ` 0.01
Standard production in actual time = 8 x 180 = 1440 units
Earnings under Straight Piece Rate:
Earnings of A = 1300 x 0.01 = ` 13.00
Earnings of B = 1500 x 0.01 = ` 15.00
Earnings under Taylor’s Differential Piece Rate:
A’s efficiency = 1300 / 1440 x 100 = 90.28%
= < 100%
A’s Earnings = 1300 x 0.01 x 80%
= ` 10.42
B’s efficiency = 1500 / 1440 x 100 = 104.17%

COST ACCOUNTING
= > 100 %

B’s Earnings = 1500 x 0.01 x 120%
= ` 18
Illustration 11
The following particulars apply to a particular job:
Standard production per hour - 6 units
Normal rate per hour - ` 1.20
Mohan produced 32 units
Ram produces 42 units
Prasad produces 50 units
Calculate the wages of these workers under Merrick Differential Piece Rate System.
Solution:
Calculation of wages of workers under Merrick Differential Piece Rate System
Normal Piece rate = 1.2 / 6 = 0.20
Standard Production = 6 x 8 (assumed hrs) = 48 units
Mohan’s efficiency = 32/48 x 100 = 66.67% (< 83%)
Mohan’s Earnings = 32 x 0.2 = ` 6.4
Ram’s efficiency = 42/48 x 100 = 87.5% (> 83 but < 100%)
Ram’s Earnings = 42 x 0.2 x 110/100 = ` 9.24
Prasad’s efficiency = 50/48 x 100 = 104.17 (> 100%)
Prasad’s Earnings = 50 x 0.20 x 120/100 = ` 12
Illustration 12
In a manufacturing concern the daily wage rate is `2.50. The standard output in a 6 day week is 200
units representing 100% efficiency. The daily wage rate is paid without bonus to those workers who
show up to 66 2/3% of the efficiency standard. Beyond this there is a bonus payable on a graded
scale as below:-
82% efficiency - 5% bonus
90% Efficiency - 9% bonus
100% efficiency - 20% bonus
Further increase of 1% for every 1% further rise in efficiency. In a 6 day week A produced 180 units; B
164 units; C 200 units; D 208 units and E 130 units.
Calculate the earnings of these workers.
Solution:
A’s efficiency = (180 / 200) x 100 = 90%
A’s Earnings = (6 x 2.5) + 9% of (6 x 2.5) = ` 16.35
B’s efficiency = (164 / 200) x 100 = 82%
B’s Earnings = (6 x 2.5) + 5% of (6 x 2.5) = ` 15.75
C’s efficiency = (200 / 200) x 100 = 100%
COST ACCOUNTING
C’s Earnings = (6 x 2.5) + 20% of (6 x 2.5) = ` 18.00

D’s efficiency = (208 / 200) x 100 = 104%
D’s Earnings = (6 x 2.5) + 24% of (6 x 2.5) = ` 18.60
E’s efficiency = (130 / 200) ×100 = 65%
E’s Earnings = 6 x 2.5 = ` 15.00
Illustration 13
Workmen of a particular grade working on 8 hour shift duty are guarantees a wage of ` 32. An
incentive scheme is in operation according to which production bonus is earned directly proportional
to performance but only after 100% performance is reached. Four workmen A,B,C and D produce
48, 60, 75 and 90 units respectively in 6 hours working on a job which has standard time of 6
minutes per unit as measured work content. Remaining 2 hours of the shift are spent in doing
unmeasured work for which no incentive bonus can be paid. Find for each workman:
(a) The production performance level achieved;
(b) Total earnings for the day.
Solution:
Statement showing computation of performance achieved and total earnings of 4 workers:
Particulars A B C D
I Standard output (6 x 60 / 6) 60 60 60 60
II Actual output 48 60 75 90
III Performance level 80% 100% 125% 150%
IV Wages for measured work (6 x 4) 24 24 24 24
V Bonus [C = 24 x 25%] [D = 24 x 50%] -- -- 6 12
VI Wages for unmeasured work (2 x 4) 8 8 8 8
VII Total earnings (IV + V + VI) 32 32 38 44
Illustration 14
The following particulars for the first week of September, 2015 relate to X and Y two workers
employed in a factory:
X Y
a) Job Completed — units 3,600 4,200
b) Out of above output rejected and unsalable 540 420
c) Time allowed 12 Mts/dozen 3 Hrs./200 units
d) Basic wage rate per hour `5 `6
e) Hours worked 45 50
The normal working hours per week are fixed at 42 hours. Bonus is paid @ 2/3 of the basic wage
rate for gross time worked and gross output produced without deduction for rejected output. The
rate of overtime for first 4 hours is paid at time plus 1/3 and for next 4 hours is paid at time plus 1/2.
From the above data calculate for each employed
a) Number of bonus hours and amount of bonus earned;
b) Total wages earned including basic wages overtime premium and bonus;
c) Direct wages cost per 100 saleable units.

0
Solution:
Particulars X Y
1. No. of units completed 3,600 4,200
2. Rejected units 540 420
3. Saleable units 3,060 3,780
4. Standard time 60 hrs 63 hrs
5. Actual time worked 45 hrs 50 hrs
6. Bonus hours 15 hrs 13 hrs
7. Amount of bonus 50 52
(15 x 5 x 2/3) (13 x 6 x 2/3)
8. Overtime wages 20 68
(3 x 5 x 4/3) [(4 x 6 x 4/3) + (4 x 6x 3/2)]
9. Basic wages 210 252
(42 x 5) (42 x 6)
10. Total wages (7 + 8 + 9) 280 372
11. Direct wage cost of 100 saleable units. 9.15 9.84
(280 / 3060) x 100 (372 / 3780) x 100
Illustration 15
From the following particulars work out the earnings for the week of a worker under
(a) Straight Piece Rate
(b) Differential Piece Rate
(c) Halsey Premium System
(d) Rowan System
Number of working hours per week 48
Wages per hour — ` 3.75
Normal time per piece — 20 Min
Normal output per week — 120
pieces Actual output for the week — 150
pieces
Differential piece rate — 80% of the piece rate when output is below standard and
120% above standard.
Solution:
Computation of earnings for the week of a worker

(a) Piece rate = (48 x 3.75) / 120 = ` 1.5
Earnings under Straight Piece Rate = 150 x 1.5 = ` 225
(b) Efficiency = (150 / 120) x 100 = 125% (> 100%)

Earnings under Differential Piece Rate = 150 x 1.5 x 120/100
= ` 270
COST ACCOUNTING
(c) Standard time for actual production = 48 x (150 / 120) = 60
hrs Earnings under Halsey Plan = (48 x 3.75) + 50/100(60 – 48) x 3.75
= 180 + 22.5 = ` 202.5
(d) Earnings under Rowan Plan = (48 x 3.75) + [(60-48 / 60) x (3.75 x 48)]
= 180 + 36 = ` 216
Illustration 16
Ten men work as a group. When the weekly production of the group exceeds standard (200 pieces
per hour) each man in the group is paid a bonus for the excess production in addition to his wages
at hourly rates. The bonus is computed thus:
The percentage of production in excess of the standard amount is found and one-half of this
percentage is considered as the men’s share. Each man in the group is paid as bonus this
percentage of a wage rate of ` 3.20 per hour. There is no relationship between the individual
workman’s hourly rate and the bonus rate. The following is the week’s records.
Hours Worked Production

Monday 90 22,100
Tuesday 88 22,600
Wednesday 90 24,200
Thursday 84 20,100
Friday 88 20,400
Saturday 40 10,200
480 1,19,600
(a) Compute the rate and amount of bonus for the week;
(b) Compute the total pay of Jones who worked 41 ½ hours and was paid `2 per hour basic and of
Smith who worked 44 ½ hours and was paid ` 2.50 per hour basic.
Solution:
Standard production in actual time = 480 x 200 = 96,000
Excess of actual production over standard = 1,19,600 – 96,000 = 23,600.
% of excess over standard = (23,600 / 96,000) x 100 = 24.58%
% of bonus = 1/2 x 24.58 = 12.29%
Bonus rate per hour = 3.2 x 12.29% = 0.393
Total bonus for week = 480 x 0.393 = ` 188.64
Computation of Total Earnings of Jones & Smith:
Particulars Jones Smith

Basic wages 41.5 x 2 83.00 44.5 x 2.5 111.25
Bonus 41.5 x 0.393 16.31 44.5 x 0.393 17.49
Total Earnings 99.31 128.74

2
Illustration 17
A manufacturer introduces a new machinery into his factory with the result that production per
worker is increased. The workers are paid by results and it is agreed for every 2% increases in average
individual output, an increase of 1% on the rate of wages will be paid.
At the time the machinery is installed the selling price of the products falls by 8-1/3%. Show the net
saving in production costs which would be required to offset the losses expected from the turnover
and bonus paid to workers.
Ist period IInd period
No.of workers 175 125
Number of articles produced 16,800 14,000
Wages paid 33,600
Total Sales 75,600
Solution:
No. of units per worker in period I — = 16,800 / 175 = 96
No. of units per worker in period II — = 14,000 / 125 = 112
Increase in production per worker — = 16 units
% of increase in output = 16/96 x 100 — = 16 2/3
% Wages in Period I = 33,600
Wages in Period II = 33,600 x (125 / 175) = 24,000
Increase in wages = 24,000 x 8.33% [16.67 x ½ = 8.33] = 2,000
Sales in Period I = 75,600
Sales in Period II = 75,600 x (14,000 / 16,800) = 63,000
Decrease in Sales = 63,000 x 8 1/3 % = 5,250
Total loss due to increase in wages & reduction in sales = 5,250 + 2,000
= 7,250
To offset the loss, the saving in other must be ` 7,250
Illustration 18
A work measurement study was carried out in a firm for 10 hours and the following information was
generated.
Units produced : 350
Idle time : 15%
Performance rating : 120%
Allowance time : 10% of standard time.
What is the standard time for task?

COST ACCOUNTING
Solution:
Calculation of standard time for task
Total time = 10 x 60 = 600 minutes
(-) Down time or Idle time @ 15% = 90 minutes
Actual time = 510 minutes
Normal Time = 510 x 120% = 612 minutes
(+) Relaxation allowance
(10% or 1/10 on standard time
i.e. 1/9 on normal time) = 68 minutes
Standard time for job = 680 minutes
Standard time for each unit = 680/350 = 1.943
minutes
Illustration 19
The extracts from the payroll of M/s. Maheswari Bros. is as follows:-
Number of employees at the beginning of 2015 150
“ “ “ “ “ “ end of 2015 200
“ “ resigned 20
“ “ discharged 5
“ replaced due to resignation and discharges 20
Calculate the Labour Turnover Rate for the factory by different methods.
Solution:
1) Separation Method = 25 ÷ (150 + 200 / 2) x 100
= 0.1429 x 100
= 14.29 %
2) Replacement Method = (20 / 175) x 100
= 11.43%
3) Flux Method = (25 + 20) ÷ 175 x 100
= 25.71%
Illustration 20
In a factory bonus to workman is paid according to Rowan Plan. Time allotted for a job is 40 hours
and the normal rate of wages is ` 1.25 per hour. The factory overhead charges are 50 paise per
hour for the hours taken.
The factory cost of a work order, executed by a worker is ` 161.875. The cost of material in each case
is `100.

4
Calculate the hours of time taken by the workman to complete the work order.

COST ACCOUNTING
Solution:
Let ‘T’ be the time taken by worker.
Earnings = 1.25 T + [(40-T) / 40] x [1.25 T]
= 1.25 T + [(50T – 1.25 T2) / 40]
= [50T + 50 T – 1.25T2] / 40
= [100 T – 1.25T2] / 40
Materials + Wages + Factory Overheads = Factory Cost
 100 + [100 T – 1.25T2] / 40 + 0.5 T = 161.875
 4000 + 100 T – 1.25T2 + 20T = 6475
 1.25T2 – 120 T + 2475 = 0
 5T2 – 480 T + 9900 = 0
 T2 – 96T + 1980 = 0
96  9216  7920
T=
2
96  36
T=
2
T = 66 (or) 30
T = 30 hours (because actual time should not be more than standard time).

6
Illustration 22
Two workmen, Vishnu and Shiva, produce the same product using the same material. Their normal
wage rate is also the same. Vishnu is paid bonus according to the Rowan System, while Shiva is paid
bonus according to Halsey System. The time allowed to make the product is 100 hours. Vishnu takes
60 hours while Shiva takes 80 hours to complete the product. The factory overhead rate is `10 per
man-hour actually worked. The factory cost for the product for Vishnu is `7,280 and for Shiva it is `
7,600.
You are required:-
(a) to find the normal rate of wages;
(b) to find the cost of materials;
(c) to prepare a statement comparing the factory cost of the products as made by the two works
men.
Solution:
Let ‘R’ be the wage rate and ‘M’ be the material cost.
Earnings of Vishnu = 60 R + [(100-60) / 100] x [60R]
= 60R + 24R = 84R
Material + Wages + Factory Overheads = Factory Cost.
M + 84R + 600 = 7,280
 M + 84 R = 6,680  (1)
Earnings of Shiva = 80 R + 50% of (100-80) x R
= 80 R + 10 R
= 90 R
Material + Wages + Factory Overheads = Factory Cost.
M + 90R + 800 = 7,600
 M + 90 R = 6,800  (2)
Solving Equation (1) & (2), we get
M + 84 R = 6,680
M + 90 R = 6,800
- 6R = -120
R = 20

COST ACCOUNTING
Substitute the value of ‘R’ in Equation (2), we get

M + 90 R = 6,800
 M + 90 (20) = 6,800
 M + 1800 = 6,800
 M = 5,000
Wages of Vishnu = (60 x 20) + [(100-60) / 100] x [60 x 20]
= 1200 + 480 = ` 1680
Wages of Shiva = (80 x 20) + 50% (100 – 80) x 20
= 1600 + 200 = ` 1800
(a) Normal Rate of wages = ` 20
(b) Material Cost = ` 5,000
(c) Statement comparing the factory cost of the products as made by the two worksmen.
Particulars Vishnu Shiva
Material 5,000 5,000
Labour 1,680 1,800
Overheads 600 800
Factory Cost 7,280 7,600
2.3 DIRECT EXPENSES (CAS – 10)
Direct expense or chargeable expense is that which can be allocated to a cost centre or cost unit
and indirect expense is that which needs to be apportioned. There may be items of expense direct
in relation to some cost centre. Thus rent and rates, heating & lighting, depreciation & insurance
are often allocated or charged directly to the appropriate service cost centre, the totals of service
department cost are however, apportioned to other cost centres before being absorbed by cost units
as overheads. These costs are direct costs of the first cost centre, but indirect costs of other
production cost centres, as well as being indirect cost of cost units.
Direct expenses as defined in CAS-10 (Limited Revision 2017), ‘Expenses relating to manufacture of a
product or rendering a service, which can be identified or linked with the cost object other than direct
material cost and direct employee cost’.
The more a factory is departmentalized, the greater will be the proportion of expenses which can
be classified as direct. Thus cost of medicines, first aid, and other expenses in connection with the
medical service are direct expenses of medical service department, but if there is no medical service
department, the expenses would have been distributed to all the cost centres at the very beginning.
The following expenses may be treated as direct expenses:-
(a) Cost of patents, royalty payment;
(b) Hire charges in respect of special machinery or plant;
(c) Cost of special patterns, cores, designs or tools;
(d) Experimental costs and expenditure in connection with models and pilot schemes;
(e) Architects, surveyors and other consultants fee;
(f) Travelling expenses to sites;
(g) Inward charges and freight charges on special material.

8
COST ACCOUNTING

0
2.4 OVERHEADS (CAS - 3)
An overhead is the amount which is not identified with any product. The name overhead might have
come due to the reason of over and above the normal heads of expenditure. It is the aggregate of
indirect material, indirect labour and indirect expenditure. The generic term used to denote indirect
material, indirect labour and indirect expenses. Thus overheads forms a class of cost that cannot be
allocated or absorbed but can only be apportioned to cost units.
In earlier days, overheads were not given much importance, because the prime cost constitutes 50-
80% of the total cost. However, with the modern trend towards the mechanisation, automation, and
mass production, overhead costs have grown considerably in size and in many undertakings the
proportion of overhead costs to the total costs of products is appreciably high. High overheads do
not indicate inefficiency if the increase in overheads is due to the following likely causes:
(a) Improved methods of managerial control like Accountancy, Production Control, Work Study,
Cost and Management Accountancy...etc. In the process of reducing costs of other elements,
viz. direct material and direct labour, overhead costs are likely to increase.
(b) Large scale production or mass production.
(c) Use of costly machines and equipments increases the amounts of depreciation, maintenance
expenditure and similar other items of overhead costs.
(d) Less human efforts are necessary with automatic machines. A major portion of the cost is
allocated direct to machines, thus increasing the machine overhead costs.
(e) Increased efficiency and productivity of labour has the effect of pushing up the overhead to
direct labour ratio.
According to CIMA, overhead costs are defined as, ‘the total cost of indirect materials, indirect labour
and indirect expenses’. Thus all indirect costs like indirect materials, indirect labour, and indirect
expenses are called as ‘overheads’. Examples of overhead expenses are rent, taxes, depreciation,
maintenance, repairs, supervision, selling and distribution expenses, marketing expenses, factory lighting,
printing stationery etc. As per CAS-3, overheads are defined as follows ‘Overheads comprise costs of
indirect materials, indirect employees and indirect expenses which are not directly identifiable or
allocable to a cost object in an economically feasible manner’
Overhead Accounting
The ultimate aim of Overhead Accounting is to absorb them in the product units produced by the
firm. Absorption of overhead means charging each unit of a product with an equitable share of
overhead expenses. In other words, as overheads are all indirect costs, it becomes difficult to charge
them to the product units. In view of this, it becomes necessary to charge them to the product units
on some equitably basis which is called as ‘Absorption’ of overheads. The important steps involved in
Overhead Accounting are as follows:-
(a) Collection, Classification and Codification of Overheads.
(b) Allocation, Apportionment and Reapportionment of overheads.
(c) Absorption of Overheads.
As mentioned above, the ultimate of Overhead Accounting is ‘Absorption’ in the product units. This
is extremely important as accurate absorption will help in arriving at accurate cost of production.
Overheads are indirect costs and hence there are numerous difficulties in charging the overheads to
the product units.

COST ACCOUNTING
Study of Overheads can be better understood from the following diagram:
Overheads
Collection Apportionment Absorption (or)

& Allocation Recovery
1. Methods
2. Causes of under (or) over
absorption
Primary Secondary 3. Methods of disposal of
under (or) over
By Nature ByClassification
Function By Element By Behaviour
1. Repetitive distribution
2. Simultaneous equation
3. Trial & Error
1. Rent 1. Manufacturing 1. Material 1. Fixed

2. Depreciation 2. Office & 2. Labour 2. Variable
Administration.
3. Such other or 3. Selling & 3. Expenses 3. Semi-variable (or)
similar nature Distribution Semi fixed
Functional Classification
Overheads can also be classified according to their functions.

2
This classification is done as given below:-
Manufacturing Overheads
As per CAS-3, Indirect Cost involved in the production process or in rendering service.
Manufacturing overheads has different names such as Production Overheads, Works Overheads,
Factory Overheads. Indirect expenses incurred for manufacturing are called as Manufacturing
Overheads. For example, factory power, works manager’s salary, factory insurance, depreciation of
factory machinery and other fixed assets, indirect materials used in production etc. It should be
noted that such expenditure is incurred for manufacturing but cannot be identified with the product
units.
Manufacturing is a separate function like administration, selling and distribution. The term
manufacturing stands for activities, which begin with receipt of order and end with completion of
finished product. Manufacturing Overhead represents all manufacturing costs other than direct
materials and direct labour. These costs cannot be identified specifically with or traced to cost object
in an economically feasible way. In other words, manufacturing overhead are indirect manufacturing
costs. The term overhead is peculiar and therefore, there is a growing tendency to prefer the term
indirect manufacturing cost to overhead. Following synonyms have been used for Manufacturing
Overhead:-
(i) Factory overhead;
(ii) Manufacturing overhead;
(iii) Factory on cost;
(iv) Works on cost;
(v) Factory burden and;
(vi) Manufacturing expenses.
Given below are a few examples of different items included in different groups of manufacturing
overhead:
Indirect Material Cost: Glue, thread, nails, rivets, lubricants, cotton waste, etc.
Indirect Labour Cost: Salaries and wages of foremen and supervisors, inspectors, maintenance,
labour, general labour; idle time etc.
Indirect Services Costs: Factory Rent, factory insurance, depreciation, repair and maintenance of plant
and machinery, first aid, rewards for suggestions for welfare, repair and maintenance of transport
system and apportioned administrative expenses etc.
Manufacturing Overhead further explains in apportionment, allocation and absorption.
Administrative Overheads
Indirect expenses incurred for running the administration are known as Administrative Overheads. As per
CAS-3, Administrative Overheads are defined as Cost of all activities relating to general management
and administration of an organisation.
As per the functional classification, Administration Overheads comprise of those indirect costs which
are related to the general administrative function in the company. Such functions are related to
policy formulation, directing the organisation and controlling the operations of the company.
Administration overheads are incurred for the benefit of organisation as a whole. Controlling them is
difficult for they do not vary with most of the variables viz. production or sales. Examples of such
overheads are, office salaries, printing and stationery, office telephone, office rent, electricity used in
the office, salaries of administrative staff etc. The size as well as control over these overheads
depends largely on decisions of management. Organisations growing very fast face the problem of
controlling Administrative Overheads. Multi-location set up leads to duplication of many
administrative costs.
Collection and Absorption of Administration Overheads
COST ACCOUNTING
The collection of overheads is done firstly by nature of the expenses through the chart of accounts.
Administrative departments in an organisation could be Corporate Office, Finance and Accounts,

4
Company Secretary, Human resources, Legal, General Administration. The overheads that are
common to all these departments are apportioned on some suitable basis e.g. in the following
manner:
(a) For Office rent, rates & taxes - Floor space as the basis,
(b) For Depreciation on office building - Floor space as the basis
(c) For Legal fees - No of cases handled as the basis
(d) For Salaries of common staff - Ratio of salaries of departments as the basis
(e) For Typist pool - No of documents typed as the basis
The classification used for cost collection is mostly combination of elemental and functional. The
behavioural classification cannot be used for booking of costs; it is used only for analysis and
decision making.
Elements Material Labour Expense

Factory or Nuts & bolts, Salaries & wages to Factory lighting &
production or consumables, foremen, supervisors, heating, factory rent,
manufacturing or lubricants, welding inspectors, maintenance power & electricity,
works overheads electrodes, cleaning labour, idle time factory insurance,
materials, nails, depreciation on
threads, ropes etc. machinery, repairs
Administrative Printing & stationery, Salary of office staff, General office rent,
Overheads office supplies managers, directors, insurance,
and other telephones, fax,
administrative travel, legal fees,
departments as IT, depreciation on
audit, credit, taxation office assets
Selling Price lists, catalogues, Salaries of sales staff & Sales office
Overheads mailings, advertising managers, commission expenses, travelling,
material such as on sales, bonus on subscription to sales
leaflets, danglers, schemes magazines, bad
samples, free gifts, debts, rent &
exhibition material insurance of
showrooms, cash
discount, brokerage,
market research
Distribution Secondary packing, Salaries of delivery staff Carriage outwards,
overheads material items used in such as drivers, forwarding
delivery vans dispatch clerk, logistic expenses, rent &
manager insurance of
warehouses &
depots, insurance,
running expenses &
depreciation of
delivery vans

COST ACCOUNTING
Classification based on behaviour

Fixed Overheads/Period Costs
The amount of overhead tends to remain fixed for all volumes of production within a certain range.
Examples of Fixed Overheads are Audit fee, Interest on capital, Depreciation of plant & machinery,
Insurance, Rent of buildings, etc. A fixed overhead represents constant expenditure incurred during
a period without regarding to the volume of production during that period. Even when production
completely ceases in a particular period, this constant amount of expenditure will continue to be
incurred partially, if not wholly. Therefore the Fixed Overheads are also known as Period Costs.
Sometimes these costs are also termed as Shutdown or Stand-by Costs.

6
Features of Fixed Costs
Fixed Costs are stated to be by and large uncontrollable, in the sense they are not influenced by the
action of a specified member of an undertaking. For example, the supervisor has practically no
control over the fixed costs like depreciation of plant & machinery. The production supervisor can
only see that the maximum possible utilization of the assets is made.
The fixed overhead amount is constant per period; the cost per unit of production varies with the
volume. This variation is inverse since with increase in production, cost per unit decreases as the
same amount of fixed overheads is spread over larger units of production.
Factors affecting the Fixed Overheads
When a plant or a department is completely idle and there is no production, several items of Fixed
Overheads disappear. Fixed Overheads are thus, of two types, viz. a lower standing fixed cost when
production is nil and a higher running fixed cost when the plant is running. For instance,
maintenance expenditure incurred at plant shutdown has to be increased to a higher level when
production starts.
Any long term change in the productive capacity of an undertaking also affects the basic characteristic
of fixed overhead. Fixed costs are constant for short term periods only, within a limited range of
capacity. Another factor that affects the fixed nature of fixed overhead is the change in basic price
level.
Graphical representation of Fixed Costs is depicted as below:
Total Fixed Overhead )`

(
Overhead (`)
t
s
o
C
Fixed Overhead per unit
X
O
Volume of Production
Fixed Costs may be broadly classified into three basic types:-

(i) Fixed costs that have no casual relationship with the volume of output and are incurred mainly
as results of policy decisions of the management. Research, development, design, employee
training, advertisement and marketing expenses are examples of this expenditure. Accountants
term such costs as discretionary fixed costs (also known as programmed costs or managed
costs).
(ii) Fixed costs that do not change significantly in the short term such as depreciation, rent, etc.
(iii) Fixed costs that are fixed for short period for a particular capacity, but change considerably
when there is a long-term change in the volume or capacity.
Variable Overheads
Variable Costs are those which vary totally in direct proportion to the volume of output. These costs
per unit remain relatively constant with changes in production. Thus Variable Costs fluctuate in total
amount but tend to remain constant per unit as production activity changes. Examples are indirect

COST ACCOUNTING
material, indirect labour, lubricants, cost of utilities, etc.

The variable overhead costs seldom reveal the characteristics of perfect variability. i.e an
expenditure which varies directly with variation in the volume of output. They simply tend to vary
rather than vary

8
directly in direct proportion of output. We come across three types of variable overhead expenses in
actual practice as explained below:-
(i) 100% variable expenses. For all production the variable expenditure remains constant.
(ii) The expense per unit of production is low at lower ranges of output but gradually increases as
production goes up.
(iii) The expenses per unit of production are more at lower ranges of output but gradually decrease
with the decrease with the increase in production.
Nature of variable expenses is shown as below:-
Overhead (`) Y
Total variable overhead
Per unit variable overhead

X
O Output or volume in units
The relationship of fixed and variable overheads with the volume of output is exhibited in the
following table. The range of output is considered as 5000-10000 units. Variable overheads are
taken at `2 per unit and fixed overheads are assumed to be at the level of `25000. Can you check
for yourself how the graph will look like for the following figures?
Semi-Variable Overheads
These are a sort of mixed or hybrid costs, partly fixed and partly variable costs. For example
Telephone expenses, include a fixed portion of annual charge plus variable charge according to the
calls. Thus total telephone expenses are semi-variable.
Semi-variable overheads are of two types:-
(i) The expenses which change with the change in volume of output, but the variation cost is less
than proportionate to change in output. Examples are power & fuel, lighting, repairs and
maintenance of buildings, etc.

COST ACCOUNTING
(ii) The costs tend to remain constant within certain range of output, then jump up and remain constant
for another range and so on.
Y
Semi-variable overheads
Overhead (`)
X
Output or Volume in units
Semi variable cost need to be classifed into fixed and variable due to the following reasons:
(a) Effective Cost Control: Fixed costs are in the nature of policy costs or discretionary costs and
as such can be controlled by the management. However variable costs can be controlled at
lower levels. Separation of two elements facilitate the fixation of responsibility, preparation of
overhead budget and exercise effective control.
(b) Decision Making: The classification is very useful in management decisions relating to utilization of
capacity. If cost information is to be of use in such problems, it is essential that fixed and variable
costs which behave differently with changes in volume should be segregated.
(c) Preparation of Break-even Charts: Separation of fixed and variable cost is essential for the study of
cost volume profit relationship and for the preparation of breakeven charts and profit charts.
(d) Marginal Costing: The basic requirement of the technique of Marginal Costing is the
separation of fixed and variable costs. While the latter are taken into consideration for the
determination of Marginal Cost and contribution, the fixed costs are treated separately.
(e) Method of Absorption Costing: Separate method may be adopted for determination of rates for
fixed and variable costs for absorption in production. Further a separate fixed overhead rate
also serves as a measure of utilization of the facilities of the undertaking; any under recovery or
under absorption denotes the idle or surplus capacity or production efficiency.
(f) Flexible Budget: In a Flexible Budget, the budgeted amounts vary with the levels of activity &
fixed cost remains constant. It is the variable cost that varies. Breakup of overhead cost into
fixed and variable is therefore necessary for establishment of budget and for the purpose of
variance analysis.

0
Allocation
CIMA defines Cost Allocation as, ‘the charging of discrete, identifiable items of cost to cost centres or
cost units’. In simple words complete distribution of an item of overhead to the departments or
products on logical or equitable basis is called allocation. Where a cost can be clearly
identified with a cost centre or cost unit, then it can be allocated to that particular cost
centre or unit. In other words, allocation is the process by which cost items are charged
directly to a cost unit or cost centre. For example, electricity charges can be allocated to
various departments if separate meters are installed, depreciation of machinery can be
allocated to various departments as the machines can be identified, salary of stores clerk
can be allocated to stores department, cost of coal used in boiler can be directly allocated
to boiler house division. Thus allocation is a direct process of identifying overheads to cost
units or cost centres. So the term allocation means allotment of whole item of cost to a
particular cost centre or cost object without any division.
Apportionment
Cost Apportionment is the allotment of proportions of items to cost centers. Wherever possible, the
overheads are to be allocated. However, if it is not possible to charge the overheads to a particular
cost centre or cost unit, they are to be apportioned to various departments on some suitable basis.
This process is called as ‘Apportionment’ of overheads. The basis for apportionment is normally
predetermined and is decided after a careful study of relationships between the base and the other
variables within the organisation. The Cost Accountant must ensure that the selected basis is the
most logical. A lot of quantitative information has to be collected and constantly updated for the
purpose of apportionment.
Distinction between Allocation & Apportionment
Although the purpose of both allocation and apportionment is identical, i.e to identify or allot the
costs to the cost centres or cost unit, both are not the same.
Allocation deals with the whole items of cost and apportionment deals with proportion of items of cost.
Allocation is direct process of departmentalization of overheads, where as apportionment needs a
suitable basis for sub-division of the cost.
Whether a particular item of expense can be allocated or apportioned does not depends on the
nature of expense, but depends on the relation with the cost centre or cost unit to which it is to be
charged.
Absorption of Overheads
Once the steps of primary and secondary distribution are carried out, what we get is total indirect
costs of production departments. The next step is to assign these totals to the individual product
units. A job or a product passes through all or many production departments before it is formed into
a finished saleable product. It is necessary to know the cost of each department it passes through
per unit. The absorption of overhead enables a Cost Accountant to recover the overhead cost spent
on each product department through each unit produced. Overhead absorption is also known as levy
or recovery of overheads. How is this done? Suppose in turning department a total of 1200 tubes
are turned and the cost of turning department overheads (after secondary distribution) are `72000,
then can we say the cost of turning per tube is `6/-? Most probably yes. This `6 per unit is called as
Overhead Absorption Rate.
Absorption means ‘recording of overheads in Cost Accounts on an estimated basis with the help of a
predetermined overhead rate, which is computed at normal or average or maximum capacity’
In general, the formula for overhead absorption rate is give
as:- Overhead Rate = Amount of Overhead / No of units of the

COST ACCOUNTING
base

2
COST ACCOUNTING
Cost Sheet Formats & Preparation

The cost concept itself being subjective, there is no standard format in which the collected costs can
be presented. It has to suit the type of business, need of the details, and management’s
requirement of control over costs. Yet a simple way to show the Total Cost of any cost unit is shown
below:
Specimen Cost Sheet
Period From …………………… Cost Units

To ……………………………………… …………
Cost Items Amount (`) Amount (`)
Direct Material
DM+DL+DExpenses= Prime Cost xxxxx
Opening Stock
Add: Purchases DM= O/S+ Purchases+ Incidental Charges-C/S xxxxx
Add: Incidental charges xxxxx
Less: Closing Stock xxxxx xxxxx
Direct Labour xxxxx
Direct Expenses xxxxx
PRIME COST xxxxx
Add: Production Overheads xxxxx
Add: Opening work in process xxxxx
Less: Closing work in process xxxxx xxxxx
FACTORY COST OR WORKS COST xxxxx
Add: Administrative Overheads xxxxx
COST OF GOODS MANUFACTURED xxxxx
Add: Opening Finished goods stock xxxxx
Less: Closing Finished goods stock xxxxx xxxxx
COST OF FINISHED GOODS SOLD xxxxx
Add: Selling & Distribution overheads xxxxx
COST OF GOODS SOLD xxxxx

Specimen Cost Sheet
Period From ………………… To ………………………………… Cost Units …………

Cost Items Amount (`) Amount (`)
Direct Material
Opening Stock xxxxx
Add: Purchases xxxxx
Add: Incidental charges xxxxx
Less: Closing Stock xxxxx xxxxx
Direct Labour xxxxx
Direct Expenses xxxxx
PRIME COST xxxxx
Add: Production overheads xxxxx
Add: Opening work in process xxxxx
Less: Closing work in process xxxxx xxxxx
FACTORY COST OR WORKS COST xxxxx
Add: Administrative Overheads xxxxx
COST OF GOODS MANUFACTURED xxxxx
Add: Opening Finished goods stock xxxxx
Less: Closing Finished goods stock xxxxx xxxxx
COST OF FINISHED GOODS SOLD xxxxx
Add: Selling & Distribution overheads xxxxx
COST OF GOODS SOLD xxxxx
Important Components of Cost Sheet
(a) Cost sheet has reference to the job or contract or a batch or production or a service undertaken
to be rendered. If the completion of the job at hand relates to more than one accounting
period, it is better that separate columns are provided to mention figures for those period. The
job or batch reference should also be mentioned on the header.
(b) If there is an estimate made for the costs, a separate column must be provided for estimated
costs against which the actual costs should be plotted to get ready comparison. This will make
cost sheets more user-friendly and meaningful.
(c) In certain cases, material may not form any significant portion of the total cost and as such may
be treated as an overhead item. In such cases, the Prime Cost will mainly constitute as labour
and other expenses.
(d) Treatment of raw material stocks should be carefully understood. As the costs are to be linked
to the units produced, the material consumption, completion of earlier period’s semifinished
goods and the finished goods sold needs to be properly computed.
Raw Material Consumed Opening Stock + Purchases – Closing Stock
One has to go into the depth of this arithmetical formula. Where do we get the figure of purchases
from? It is from the suppliers invoices for purchase of stockable material. It also should include all
charges incidental to purchase of goods like carriage, insurance, customs duty etc. which is directly
associated with the incoming material.

COST ACCOUNTING
As we know that the stocks are always valued at cost or market price whichever is less. This norm
has to be applied to the rates of all the items of material in stock, and then the total valuation of
stock is done. The stock ledger records all receipts and issues of the quantity and rate of material
items. The valuation of material issues has to be properly done based on correctly chosen method of
issue pricing. This summary figure as per the issue column should exactly match with the raw
material consumed figure as included in the cost sheet.
Illustration 1
Following data is available from the cost records of a company for the month of March 2017:
(1) Opening stock of job as on 1st March 2017
Job no. A 99: Direct Material `80, Direct Wages `150 and Factory Overheads `200
Job no. A 77: Direct Material `420, Direct Wages `450 and Factory Overheads `400
(2) Direct material issued during the month of February 2017 was:
Job no A 99 Sol.99------DM = 80*120=rs.8400
DW=150*120=18000
`120 Job no A FO= 200*120=24000
77 `280 Job no
A 66 `225 Job
no A 55 `300
(3) Direct labour details for March 2017 were:
Job no Hours Amount (`)
A 99 400 600
A 77 200 450
A 66 300 675
A 55 100 225
(4) Factory Overheads are applied to jobs on production according to direct labour hour rate which
is `2 per hour.
(5) Factory Overhead incurred in March 2017 were `2100.

(6) Job numbers A 99 & A 77 were completed during the month. They were billed to the customers
at a price which included 15% of the price of the job for Selling & Distribution expenses and
another 10% of the price for Profit.
Prepare:
(a) Job cost sheet for job number A 77 and A 99.
(b) Determine the selling price for the jobs.
(c) Calculate the value of work in process.
Solution:
Remarks :
(1) The Factory Overheads actually incurred are ` 2100. This amount to be apportioned on the
basis of labour hours. So the rate to be considered as ` 2.1per unit = (2100/1000) and not `2
per unit. If we consider the above mentioned point the calculations for Job Sheets & for the
work in progress will change accordingly.
(2) Work in progress is to be calculated for the incomplete jobs hence job no. A 66 and A 55 should
only be included in the calculations of work in progress.
Job Cost Sheets for the month of March 2017 Amount (`)
Cost Items Job A 77 Job A 99

Direct Material issued 280 120
Direct labour spent 450 600
Prime Cost 730 720
Factory Overheads @ ` 2.1 per hour (200×2.1) 420 (400×2.1) 840
Add: Opening WIP (Material + Labour + Overheads) 1,270 430
Factory Cost 2,420 1,990
Add: Selling & Distribution Overheads (Note 1) 484 398
Cost of Sales 2,904 2,388
Profit (Note 1) 323 265
Billing price for the job 3,227 2,653
Note 1
S&D and profit are given in indirect way. 480 300
Assume Selling price as 100 320 200
Less: S & D @ 15% (15)
Less: Profit @ 10% (10)
Balance has to be the Factory Cost 75
S & D price will be 15/75 of Factory
Costs Profit will be 10/75 of Factory Cost

COST ACCOUNTING
Computation of Work in Process for March 2017 Amount (`)
Items
Opening balance as on 1 March
st
Job A 99 430
Job A 77 1,270 1,700
Material issued during the month of March Job A 99 120
Job A 77 280
Job A 66 225
Job A 55 300 925
Direct Labour Job A 99 600
Job A 77 450
Job A 66 675
Job A 55 225 1,950
Factory Overheads on 1000 hours @ ` 2.1 2,100
Factory Cost 6,675
Less: Factory Cost of completed jobs Job A 77 2,420
Job A 99 1,990 4,410
Closing work in process as on 28th March 2017 2,265
Another way to calculate WIP is

Job A 66 and A 55 are in progress & WIP includes only incomplete Jobs.
Direct Material (225+300) 525
Direct Labour (675+225) 900
Factory Overheads [2.1 *(300+100)] 840
Total WIP 2,265
Illustration 2
Prepare Cost Sheet for an engineering company which produces standard components in batches of
1000 pieces each. A batch passes through three processes viz. Foundry, Machining & Assembly.
The materials used for a batch number 001 were: Foundry 1300 tonnes @ `50 per tonne of which
50 tonnes were sent back to stores.
Other details
Process Direct Labour Overheads

Foundry 200 Hrs @ ` 10 ` 15 per Labour Hour
Machining 100 Hrs @ ` 5 ` 20 per Labour Hour
Assembly 100 Hrs @ ` 15 ` 10 per Labour Hour
A comparison of actual costs with estimated cost discloses that material and overheads have
exceeded the estimates by 20% whereas the estimated labour cost is 10% more than the actual.
Show the variances with respect to the estimates

Solution:
Cost sheets for the Batch number 001
Standard batch size 1000 pieces
Cost Items Actual Estimated Variance F/A

Direct material issued (1250 x 50) 62,500 52,083 (10,417) A
Direct labour spent
Foundry - 200 x 10 2,000 2,200 200 F
Machining - 100 x 5 500 550 50 F
Assembly - 100 x 15 1,500 1,650 150 F
Prime Cost 66,500 56,483 (10,017) A
Factory Overheads applied
Foundry - 200 x 15 3,000 2,500 (500) A
Machining - 100 x 20 2,000 1,667 (333) A
Assembly - 100 x 10 1,000 833 (167) A
Factory Cost 72,500 61,483 (11,017) A
Cost per unit (Factory Cost/1000) 72.5 61.48 11.02
Illustration 3
An advertising agency has received an enquiry for which you are supposed to submit the quotation.
Bill of material prepared by the production department for the job states the following requirement
of material:
Paper 10 reams @ `1800 per ream
Ink and other printing material `5000
Binding material & other consumables `3000
Some photography is required for the job. The agency does not have a photographer as an
employee. It decides to hire one by paying `10000 to him. Estimated job card prepared by
production department specifies that service of following employees will be required for this job:
Artist (`12000 per month) 80 hours
Copywriter (`10000 per month) 75 hours
Client servicing (`9000 per month) 30 hours
The primary packing material will be required to the tune of `4000. Production Overheads 40% of
direct cost, while the S & D Overheads are likely to be 25% on Production Cost. The agency expects
a profit of 20% on the quoted price. The agency works 25 days in a month and 6 hours a day.

COST ACCOUNTING
Solution:
Quotation for a Printing Job
Items Amount (`) Amount (`)

Direct material required:
Paper 10 x 1800 18,000
Ink & other printing material 5,000
Binding material & consumables 3,000
Primary packing material 4,000 30,000
Direct labour spent
Artist [12,000/(25 x 6)] x 80 6,400
Copy writer [10,000 / (25 x 6)] x 75 5,000
Client Servicing [9,000 / (25 x 6)] x 30 1,800 13,200
Photographer’s charges 10,000
Prime Cost 53,200
Factory Overheads applied @ 40% on Direct Cost 21,280
Production Cost 74,480
S & D overheads applied @ 25% on Production Cost 18,620
Total Cost 93,100
Profit (20% on price i.e. 25% on cost) 23,275
Price to be quoted 1,16,375
Illustration 4
The following figures were extracted from the Trial Balance of a company as on 31st December 2016.
Particulars Debit Credit

Inventories
Raw Material 1,40,000
WIP 2,00,000
FG 80,000
Office Appliances 17,400
Plant and Machinery 4,60,500
Buildings 2,00,000
Sales 7,68,000
Sales Returns 14,000
Material purchased 3,20,000
Freight on materials 16,000
Purchase returns 4,800

Direct labour 1,60,000
Indirect labour 18,000
Factory supervision 10,000
Factory repairs & upkeep 14,000
Heat, light & power 65,000
Rates & taxes 6,300
Misc factory expenses 18,700
Sales commission 33,600
Sales travelling 11,000
Sales Promotion 22,500
Distribution department salaries & wages 18,000
Office salaries 8,600
Interest on borrowed funds 2,000
Further details are given as follows:

Closing inventories are Material `180000, WIP `192000 & FG `115000.
Accrued expenses are Direct Labour `8000, Indirect Labour `1200 & interest `2000.
Depreciation should be provided as 5% on Office Appliances, 10% on Machinery and 4% on
Buildings. Heat, light and power are to be distributed in the ratio of 8:1:1 among factory, office and
distribution
respectively.
Rates & taxes apply as 2/3rd to the factory and 1/3rd to office.
Depreciation on building to be distributed in the ratio of 8:1:1 among factory, office and distribution
respectively
Prepare a Cost Sheet showing all important components and also a condensed P & L Account for the
year.
Solution:
Particulars Amount (`) Amount (`)

Direct Materials
Opening stock 1,40,000
Add: Purchases 3,20,000
Add: Freight 16,000
Less: Returns (4,800)
Less: Closing Stock (1,80,000) 2,91,200
Direct Labour 1,60,000
Add: Accrued 8,000 1,68,000
Prime Cost 4,59,200

COST ACCOUNTING
Factory Overheads:
Indirect labour 18,000
Accrued indirect labour 1,200
Factory supervision 10,000
Repairs & upkeep 14,000
Heat, Light & power 52,000
Rates & taxes 4,200
Misc. Factory expenses 18,700
Depreciation on plant & machinery 46,050
Depreciation on buildings 6,400
1,70,550
Add: Opening WIP 2,00,000
Less: Closing WIP (1,92,000) 1,78,550
Factory Cost 6,37,750
Administration Overheads
Heat Light & power 6,500
Rates & taxes 2,100
Depreciation on buildings 800
Depreciation on office appliances 870
Office salaries 8,600
18,870
Add: Opening FG stock 80,000
Less: Closing FG Stock (1,15,000) (16,130)
Cost of Production of saleable units 6,21,620
Selling & Distribution overheads
Heat & light 6,500
Depreciation on buildings 800
Sales commission 33,600
Sales travelling 11,000
Sales promotion 22,500
Distribution department expenses 18,000 92,400
Cost of Sales 7,14,020
Condensed P & L Account for the year ended 31-12-2016

Sales Income 7,68,000
Less: Returns (14,000) 7,54,000
Cost of Sales as above 7,14,020
Interest on borrowings (2,000 + 2,000) 4,000
Net Profit 35,980

Illustration 5
PR Ltd. manufactures and sells a typical brand of Tiffin Boxes under its on brand name. The installed
capacity of the plant is 1,20,000 units per year distributable evenly over each month of calendar
year. The Cost Accountant of the company has informed the following cost structure of the product,
which is as follows:
Raw Material ` 20 per unit.
Direct Labour ` 12 per unit
Direct Expenses ` 2 per unit
Variable Overheads ` 16 per unit.
Fixed Overhead ` 3,00,000.
Semi-variable Overheads are as follows:

` 7,500 per month upto 50% capacity & Additional ` 2,500 per month for every additional 25%
capacity utilization or part thereof.
The plant was operating at 50% capacity during the first seven months of the calendar year 2016, at
100% capacity in the remaining months of the year.
The selling price for the period from 1st Jan, 2016 to 31st July, 2016 was fixed at ` 69 per unit. The
firm has been monitoring the profitability and revising the selling price to meet its annual profit
target of
` 8,00,000. You are required to suggest the selling price per unit for the period from 1st August 2016 to
31st December 2016.
Prepare Cost Sheet clearly showing the total and per unit cost and also profit for the period.
1. from 1st Jan. to 31st July, 2016
2. from 1st Aug. to 31st Dec, 2016.
Solution:
Cost Sheet for the period Amount (`)
Particulars 50% capacity utilization (10000 100% capacity utilization –

units P.M) – 35000 units, seven 50000 units, Five months
months 1st Jan to 31st July, 2016 1st Aug to 31st Dec, 2016
Raw Materials 7,00,000 10,00,000
Direct Labour 4,20,000 6,00,000
Direct Expenses 70,000 1,00,000
Variable overheads 5,60,000 8,00,000
Fixed Overheads 1,75,000 1,25,000
Semi-Variable Overheads 52,500 62,500
Total Costs 19,77,500 26,87,500
Profit 4,37,500 3,62,500
Sales 24,15,000 30,50,000
Selling Price Per Unit 69.00 61.00
Cost Per Unit 56.50 53.75

COST ACCOUNTING
Illustration 6
X Ltd. Provides you the following figures for the year 2015-16:
Particulars Amount (`)
Direct Material 3,20,000
Direct Wages 8,00,000
Production Overheads (25% variable) 4,80,000
Administration Overheads (75% Fixed) 1,60,000
Selling and Distribution Overheads (2/3rd Fixed) 2,40,000
Sales @ ` 125 per unit 25,00,000
For the year 2016-17, it is estimated that:
1. Output and sales quantity will increase by 20% by incurring additional Advertisement Expenses of
` 45,200.
2. Material prices will go up 10%.
3. Wage Rate will go up by 5% along with, increase in overall direct labour efficiency by 12%.
4. Variable Overheads will increase by 5%.
5. Fixed Production Overheads will increase by 33 1/3 %
Required:
(a) Calculate the Cost of Sales for the year 2015-2016 and 2016-2017.
(b) Find out the new selling price for the year 2016-2017.
(i) If the same amount of profit is to be earned as in 2015-2016.
(ii) If the same percentage of profit to sales is to be earned as in 2015-2016.
(iii) If the existing percentage of profit to sales is to be increased by 25%.
(iv) If Profit per unit ` 10 is to be earned.
Solution:
(a) Statement showing the Cost of Sales Amount (`)
Particulars For 20000 units For 24000 units
A. Direct Materials 3,20,000 4,22,400
[`3,20,000 x 110% x 120%]
B. Direct wages 8,00,000 9,00,000
[` 8,00,000 x (105/100) x (100/112) x
120%]
C. Prime Cost 11,20,000 13,22,400
D. Add: Production Overheads
Variable Production Overheads 1,20,000 1,51,200
[` 4,80,000 x 25%] [`1,20,000 x 105% x 120%]
Fixed Production Overheads 3,60,000 4,80,000
[` 4,80,000 x 75%] [` 3,60,000 x 133%]
E. Works Cost (C + D) 16,00,000 19,53,600

F. Add: Administration Overheads
Variable Admn. Overheads 40,000 50,400 [` 40,000 x 105% x 120%]
Fixed Admn. Overheads 1,20,000 1,20,000
G. Cost of Goods Produced 17,60,000 21,24,000
H. Add: Selling and Distribution
Overheads
80,000 1,00,800 [` 80,000 x 105% x 120%]
Variable Selling & Distribution OHs
Fixed Selling & Distribution OHs 1,60,000 1,60,000
Additional Advertisement Exp. 45,200
I. Cost of Sales [G + H] 20,00,000 24,30,000
(b)
(i) New Selling Price = (` 24,30,000 + ` 5,00,000)/24,000 units = ` 122.08
(ii) New Selling Price = (` 24,30,000 + 25% or ` 24,30,000)/24,000 units = ` 126.5625
(iii) New Selling Price = (` 24,30,000 + 1/3rd or ` 24,30,000)/24,000 units = ` 135
(iv) New Selling Price = (` 24,30,000 + (24,000 x ` 10) / 24,000 units = ` 111.25
Illustration 7
The following are the costing records for the year 2017 of a manufacturer:
Production 10,000 units; Cost of Raw Materials ` 2,00,000; Labour Cost ` 1,20,000; Factory Overheads
` 80,000; Office Overheads ` 40,000; Selling Expenses ` 10,000, Rate of Profit 25% on the Selling Price.
The manufacturer decided to produce 15,000 units in 2017. It is estimated that the cost of raw
materials will increase by 20%, the labour cost will increase by 10%, 50% of the overhead charges
are fixed and the other 50% are variable. The selling expenses per unit will be reduced by 20%. The
rate of profit will remain the same.
Prepare a Cost Statement for the year 2017 showing the total profit and selling price per unit.
Solution:
Statement of Cost & Profit (Cost Sheet)
Sol-
(Output 10,000 units) Amount (`)
Particulars Cost per unit Total Cost
Raw Materials 20 2,00,000
Labour 12 1,20,000
PRIME COST 32 3,20,000
Add: Factory Overhead 8 80,000
WORKS COST 40 4,00,000
Add: Office Overhead 4 40,000
COST OF PRODUCTION 44 4,40,000
Add: Selling Expenses 1 10,000
COST OF SALES 45 4,50,000
Add: Profit (25% on Selling Price or 33.33% on Cost of Sales) 15 1,50,000
SELLING PRICE 60 6,00,000

COST ACCOUNTING
Statement of Cost & Profit (Cost Sheet)
(Output 15,000 units) Amount (`)
Particulars Cost per unit Total Cost

Raw Materials (` 20 x 120% x 15,000) 24.00 3,60,000
Labour (` 12 x 110% x 15,000) 13.20 1,98,000
PRIME COST 37.20 5,58,000
Add: Factory Overhead (` 80,000 x 50% + ` 4 x 15,000) 6.67 1,00,000
WORKS COST 43.87 6,58,000
Add: Office Overhead (` 40,000 x 50% + ` 2 x 15,000) 3.33 50,000
COST OF PRODUCTION 47.20 7,08,000
Add: Selling Expenses (` 1 x 80% x 15,000) 0.80 12,000
COST OF SALES 48.00 7,20,000
Add: Profit (25% on Selling Price or 33.33% on Cost of Sales) 16.00 2,40,000
SELLING PRICE 64.00 9,60,000
4.2 ITEMS EXCLUDED FROM COST AND NORMAL AND ABNORMAL ITEMS/COST
Items Excluded from Cost Accounts

There are certain items which are included in financial accounts of a manufacturing concern but shall
not to be included in cost accounts since they are not related to cost of production. These items fall
into three categories:-
Appropriation of profits:
(i) Appropriation to sinking funds
(ii) Dividends paid
(iii) Taxes on income and profits
(iv) Transfers to general reserves
(v) Excess provision for depreciation of buildings, plant etc. and for bad debts
(vi) Amount written off – goodwill, preliminary expenses, underwriting commission, discount on
debentures issued; expenses of capital issue etc.
(vii) Capital expenditures specifically charged to revenue
(viii) Charitable donation
Matters of pure finance

(a) Purely financial charges:-
(i) Losses on sale of investments, buildings, etc.
(ii) Expenses on transfer of company’s office
(iii) Interest on bank loan, debentures, mortgages, etc.
(iv) Damages payable

(v) Penalties and fines
(vi) Losses due to scrapping of machinery
(vii) Remuneration paid to the proprietor in excess of a fair reward for services rendered
(b) Purely financial incomes:-

(i) Interest received on bank deposits
(ii) Profits made on the sale of investments, fixed assets, etc.
(iii) Transfer fees received
(iv) Rent receivable
(v) Interest, dividends, etc. received on investments.
(vi) Brokerage received
(vii) Discount, commission received
Abnormal gains and losses:-

(i) Losses or gains on sale of fixed assets.
(ii) Loss to business property on account of theft, fire or other natural calamities.
In addition to above abnormal items (gain and losses) may also be excluded from cost accounts.
Alternatively, these may be taken to costing profit and loss account.
4.5 RECONCILIATION OF COST ACCOUNTING RECORDS WITH FINANCIAL ACCOUNTS
Where no separate accounts are maintained for costing and finance, the question of reconciliation
does not arise. But where the cost and financial accounts are maintained independently of each
other, it is indispensable to reconcile them. Though both the sets of accounts are same as far as the
basic transactions are concerned but there are differences in the profits of two sets of books.
Reasons for difference in profits of cost and financial accounts

(i) Items shown in Financial Accounts
There are a number of items which are included in financial accounts but do not find place in
cost accounts. They may be items of income or expenses, the former increases the profit and
latter reduces the profit.
A. Purely Financial Charges

(a) Loss arising from the sale of fixed assets.
(b) Loss on sale of investments, discount on debentures, etc.
(c) Interest on bank loan, mortgage and debentures.
(d) Expenses of companies ‘Share Transfer Office’.
B. Appropriation of Profits
(a) Donations and Charities
(b) Income Tax
(c) Dividend Paid
(d) Transfer to Reserves

COST ACCOUNTING
C. Writing off Intangible and Fictitious Assets

(a) Goodwill
(b) Patents & Copyrights
(c) Advertisement
(d) Preliminary Expenses
D. Pure Financial Incomes

(a) Rent received or Profit on Sale of Fixed Assets
(b) Share transfer fee received
(c) Interest received on Bank Deposits
(d) Dividend received etc.
(ii) Items shown only in Cost Accounts

There are certain items which are included in cost accounts and not in financial accounts. Such
items are very few.
E.g. Interest on capital employed, rent for own premises etc.

(iii) Over or Under Absorption of Overheads.
Overheads are absorbed in Cost Accounts on a certain predetermined estimated basis and in
Financial Accounts, actual amounts incurred are recorded. If there is any over or under
absorption it leads to difference in the profits of both sets of books.
(iv) Differences due to different basis of stock valuation and depreciation methods.
Objects of Reconciliation
(a) To assure the mathematical accuracy and reliability of cost accounts
(b) To have proper cost control and ascertainment
(c) To find out the reasons for the profit or loss shown by the financial accounts
(d) To ensure correct profit or loss in financial accounts
(e) To ensure true and fair view of balance sheet of the business concern
Procedure for reconciliation

Take Profits as per Financial Accounts.
Add :
(a) Items of income included in Cost Accounts but not in Financial Accounts.
(b) Items of expenditure included in Financial and not in Cost Accounts.
(c) Amounts by which items of income have been shown in excess in Cost Accounts over the
corresponding entries in Financial Accounts.
(d) Amounts by which items of expenditure have been shown in excess in Financial Accounts over
the corresponding entries in Cost Accounts.
(e) Under absorption of overheads in Cost Accounts.
(f) The amount by which closing stock of inventory is overvalued in Cost Accounts.
(g) The amount by which opening stock of inventory is undervalued in Cost Accounts.
Less :
(a) Items of income included in Financial Accounts but not in Cost Accounts.
(b) Items of expenditure (as interest on Capital, Rent on owned premises etc.) included in Cost
Accounts but not in Financial Accounts.
(c) Amounts by which items of expenditure have been shown in excess in Cost Accounts as
compared to the corresponding entries in Financial Accounts.
(d) Amounts by which items of incomes have been shown in excess in Financial Accounts as
compared to the corresponding entries in Cost Accounts.
(e) Over absorption of overheads in Cost Accounts.
(f) The amount by which closing stock of inventory is undervalued in Cost Accounts.
(g) The amount by which opening stock of inventory is overvalued in Cost Accounts.

Illustration 13
The net profits of a manufacturing company appeared at ` 64,500 as per financial records for the
year ended 31st December, 2016. The cost books however, showed a net profit of ` 86,460 for the
same period. A careful scrutiny of the figures from both the sets of accounts revealed the following
facts.
`
(i) Income-tax provided in financial books 20,000
(ii) Bank Interest (Cr) in financial books 250
(iii) Work overhead under recovered 1,550
(iv) Depreciation charged in financial records 5,600
(v) Depreciation recovered in cost 6,000
(vi) Administrative overheads over-recovered 850
(vii) Loss due to obsolescence charged in financial accounts 2,800
(viii) Interest on Investments not included in cost accounts 4,000
(ix) Stores adjustments (Credit in financial books) 240
(x) Loss due to depreciation in stock 3,350

value Prepare Reconciliation
Statement.
Solution:
Statement showing reconciliation of profit shown by cost and financial accounts as on 31-12-2016:

Profit as per Financial Accounts 64,500
Add: Income tax provided in financial books only. 20,000
Works overhead under recovered 1,550
Loss to obsolescence considered. Financial A/c only. 2,800
Loss due to depreciation in stock 3,350 27,700
92,200
Less: Bank interest credited in financial books. 250
Over recovery of depreciation 400
Administration OH’s over recovered 850
Interest on investment not included in cost books 4,000
Stores adjustment 240 5,740
Profit as per Cost Accounts 86,460

COST ACCOUNTING
Study Note - 5
METHODS OF COSTING
5.1 Job Costing

5.2 Batch Costing
5.3 Contract Costing
5.4 Process Costing – Joint & By-Products
5.5 Operating Costing or Service Costing – Transport, Hotel and Hospital
5.1 JOB COSTING
Methods or Types of Costing

Costing is the technique and process of ascertaining costs. In order to do the same, it is necessary
to follow a particular method of ascertaining cost. Different methods of costing are applied to
different industries depending upon the type of manufacture and their nature. Broadly the costing
methods are classified into the following:
(a) Specific Order Costing (Job or Terminal Costing)
(b) Operation Costing or Process or Period Costing
Specific Order Costing: Specific order costing is the category of basic costing methods applicable
where the work consists of separate jobs, batches or contracts each of which is authorised by a
specific order or contract. It includes job costing consisting batch costing and contract costing.
Job Order Costing

CIMA London defines job costing as “the category of basic costing methods which is applicable
where the work consists of separate contracts, jobs or batches each of which is authorised by
specific order or contract”.
In job costing, there is no averaging of costs except to the extent that in the ascertainment of unit
cost, the cost of a lot of products in one order is obtained. A job or an order may extend to several
accounting periods and job costs are, therefore, not related to particular periods.

Job cost accounting is followed in three types of manufacturing organisations:
(i) Jobbing concerns
(ii) Small firms
(iii) Large enterprises manufacturing a variety of products
.
Advantages of Job Costing

Job costing offers the following advantages:
(a) The cost of material, labour and overhead for every job or product in a department is available
daily, weekly or as often as required while the job is still in progress.
(b) On completion of a job, the cost under each element is immediately ascertained. Costs may be
compared with the selling prices of the products in order to determine their profitability and to
decide which product lines should be pushed or discontinued.
(c) Historical costs for past periods for each product, compiled by orders, departments, or
machines, provide useful statistics for future production planning and for estimating the costs of
similar jobs to be taken up in future. This assists in the prompt furnishing of price quotations for
specific jobs.
(d) The adoption of predetermined overhead rates in job costing necessitates the application of
a system of budgetary control of overhead with all its advantages.
(e) 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.
(f) Spoilage and defective work can be easily identified with specific jobs or products.
(g) Job costing is particularly suitable for cost-plus and such other contracts where selling price is
determined directly on the basis of costs.
Limitations of Job Costing

The limitations of job costing are:
(a) Job costing is comparatively more expensive as more clerical work is involved in identifying each
element of cost with specific departments and jobs.

COST ACCOUNTING
(b) With the increase in the clerical processes, chances of errors are enhanced.
(c) The cost as ascertained, even where they are compiled very promptly, are historical as they are
compiled after incidence.
(d) The cost compiled under job costing system represents the cost incurred under actual
conditions of operation. The system does not have any scientific basis.
Job Cost Card/Sheet

Each job is dissimilar to other due to specific and customised requirements. In order to ascertain
cost of a particular job, it is necessary to record all the expenditure related to a job separately. For
this purpose, job cost card/sheet is used. Job cost card is a cost sheet, where the quantity of
materials issued, hours spent by different class of employees, amount of other expenses and share
of overheads are recorded. This is helpful in knowing the total cost, profitability etc. of a job. A
format of job cost card/sheet is shown below.
JOB COST SHEET
Description: Job No:

Blue print No: Quantity:
Material No: Date of delivery:
Reference No: Date commenced:
Date finished:
Date Reference Details Material Labour Overhead
Total
Summary of Costs Estimated (`) Actual (`)
Direct material cost

Direct wages For the job:
Production overhead Units produced:
PRODUCTION COST Cost/unit:
Administration and Remarks:

Selling& Distribution Prepared by:
overheads
Checked by:
TOTAL COST
Profit/Loss
SELLING PRICE

Accounting of Costs for a Job
Entries in Control Accounts
1. For purchase of materials:

Stores Ledger Control A/c...................................................................................... Dr.
To Cost Ledger Control A/c*
2. For the value of direct materials issued to job:
Work-in-Process control A/c ................................................................................. Dr.
To Stores Ledger Control A/c
3. For return of direct materials from jobs:
Stores Ledger Control A/c...................................................................................... Dr.
To Work-in-Process Control A/c
4. For return of materials to suppliers:
Cost Ledger Control A/c......................................................................................... Dr.
5. For indirect materials:
Factory Overhead Control A/c ............................................................................... Dr.
6. For wages paid:
Wages Control A/c ................................................................................................. Dr.
To Cost Ledger Control A/c
7. For direct wages incurred on jobs:
Work-in-Process Control A/c ................................................................................. Dr.
To Wages Control A/c
8. For indirect wages:
To Wages Control A/c
9. For any indirect expense paid:
To Cost Ledger Control A/c
10. For charging overhead to jobs:
Work-in-Process Control A/c ................................................................................. Dr.
To Factory Overhead Control A/c
11. For the total cost of job completed:
Cost of Sales A/c..................................................................................................... Dr.
To Work-in-Process Control A/c
12. The balance of Cost of Sales A/c is transferred to Costing Profit and loss A/c;
For such transfer:
Costing Profit and loss A/c..................................................................................... Dr.
To Cost of Sales A/c
13. For the sales value of jobs completed:
Cost Ledger Control A/c......................................................................................... Dr.
To Costing profit and loss A/c**
Note:
* General ledger adjustment account is the other name of Cost Ledger Control Account.
** The balance of Costing profit and loss account shall now represent profits or loss. The balance of
Cost Ledger Control Account shall be carried forwarded. With the balance on all the accounts
Trial Balance can be drawn.

COST ACCOUNTING
Reports in Job Costing System

Report on profits on completed jobs
A statement may be prepared monthly to indicate the gross profit earned on all jobs completed
during the month. This statement is useful for the management for evaluating past performances.
Net profit analysis may also be made in a similar manner if administration, selling and distribution
overheads for the job are included in the statement.
Report on cost variances

If cost estimates are developed, a cost variance report showing the deviations of actual costs from
the estimated costs may be prepared in order that significant differences may be brought to light
and investigated. The report may be prepared separately for a job, or for a department showing the
variances in respect of all jobs undertaken by the department during a period.
Illustration 1
As newly appointed Cost Accountant, you find that the selling price of Job No. 9669 has been
calculated on the following basis:

Materials 12.08
Direct Wages – 22 hours at 25 paise per hour 5.50
Department A – 10 hours,
B – 4 hours,
C - 8 hours
Prime Cost 17.58
Plus 33% on Prime 5.86
Cost
23.44
An analysis of the previous year’s profit and loss account shows the following:
Particulars Amount (`) Particulars Amount (`)

Materials Used 77,500 Factory Overheads:
Direct Wages: A 2,500
A 5,000 B 4,000
B 6,000 C 1,000
C 4,000 Selling Costs 30,000
You are required to:

(a) Calculate and enter the revised costs using the previous year’s figures as a basis;
(b) Draw up a Job Cost Sheet;
(c) Add to the total job cost 10% for profit and give the final selling price.

Solution:
(a)
In order to draw up Job Cost Sheet, the factory overhead rates of different departments and
percentage of selling cost will have to be determined first on the basis of previous year’s figures as
follow:
Factory Overhead Rates: Amount (`)

Particulars Department
A B C
Direct Wages (i)
Factory Overheads (ii) 2,500 4,000 1,000
Direct Labour Hours (D.W. x 4) (iii) 20,000 24,000 16,000
Factory Overhead Rates per hour (ii ÷ iii) 0.125 0.167 0.063
Working Notes:
Materials used 77,500

Direct Wages [A = 5,000, B = 6,000, C = 4,000] 15,000
Factory Overhead [A = 2,500, B = 4,000, C = 1,000] 7,500
Works Cost 1,00,000
Selling Costs 30,000
`30,000
Percentage of Selling Cost on Works Cost =
`1,00,000 × 100 = 30%
(b) Cost Sheet
Job No. 9669 Period

Materials 12.08
Direct Wages:
Dept. A 2.50
Dept. B 1.00
Dept. C 2.00 5.50
Prime Cost 17.58
Factory Overheads:
Dept. A (10 hours. @ ` 0.125) 1.25
Dept. B (4 hours. @ ` 0.167) 0.67
Dept. C (8 hours. @ ` 0.063) 0.50 2.42
Works Cost 20.00
Selling Cost (30% of Works Cost) [Ref. working notes] 6.00
Cost of Sales 26.00
(c)
Profit (10% on Cost) 2.60
Selling Price 28.60

COST ACCOUNTING
Illustration 2
A work order for 100 units of a commodity has to pass through four different machines of which the
machine hour rates are: Machine P – ` 1.25, Machine Q – ` 2.50, Machine R – ` 3 and Machine S – ` 2.25
Following expenses have been incurred on the work order – Materials ` 8,000 and Wages ` 500.
Machine - P has been engaged for 200 hours. Machine - Q for 160 hours, Machine - R for 240 hours
and Machine - S for 132 hours.
After the work order has been completed, materials worth ` 400 are found to be surplus and are returned
to stores.
Office overhead used to be 40% of works costs, but on account of all-round rise in the cost of
administration, distribution and sale, there has been a 50% rise in the office overhead expenditure.
Moreover, it is known that 10% of production will have to be scrapped as not being upto the
specification and the sale proceeds of the scrapped output will be only 5% of the cost of sale.
If the manufacturer wants to make a profit of 20% on the total cost of the work order, find out the selling
price of a unit of commodity ready for sale.
Solution:
Statement showing the selling price of a unit

Materials used (` 8,000 – `400) 7,600
Direct Wages 500
Prime Cost 8,100
Works Overhead at machine hour rate:
Machine - P For 200 hours @ ` 1.25 per hour 250
Machine - Q For 160 hours. @ ` 2.50 per hour 400
Machine - R For 240 hours. @ ` 3 per hour 720
Machine - S For 132 hours. @ ` 2.25 per hour 297 1,667
Works Cost 9,767
Administration Overhead at 60% of works cost 5,860
15,627
Less: Sale proceeds of Scrap (5% of 10% of ` 15,627) 78
Total Cost of the work order 15,549
Profit at 20% of total Cost 3,110
Selling Price of 100 units 18,659
Selling Price of a unit 186.59
Note: It was known before that 10% of production will have to be scrapped, therefore, inputs must have
been made taking this factor into consideration. No other adjustment is necessary except deducting
the value of scrap from the cost of production.
Illustration 3
The data pertaining to Heavy Engineering Ltd. using are as follows at the end of 31.3.2018. Direct material
` 9,00,000; Direct wages ` 7,50,000; Selling and distribution overhead ` 5,25,000; Administrative overhead
` 4,20,000, Factory overhead ` 4,50,000 and Profit ` 6,09,000.

(a) Prepare a cost sheet showing all the details.
(b) For 2017-18, the factory has received a work order. It is estimated that the direct materials would be
` 12,00,000 and direct labour cost ` 7,50,000. What would be the price of work order if the
factory intends to earn the same rate of profit on sales, assuming that the selling and
distribution overhead has gone up by 15%? The factory recovers factory overhead as a
percentage of direct wages and administrative and selling and distribution overheads as a
percentage of works cost, based on the cost rates prevalent in the previous year.
Solution:
(a) Statement of Cost
Direct Materials 9,00,000
Direct Wages 7,50,000
Prime Cost 16,50,000
Factory Overheads (60% of wages) 4,50,000
Works Cost 21,00,000
Administration Overhead (20% of works cost) 4,20,000
Cost of Production 25,20,000
Selling & Distribution Overheads (25% of Works Cost) 5,25,000
Profit (1/5 of Cost) 6,09,000
Sales 36,54,000
(b) Estimated price of work order
Direct Materials 12,00,000
Direct Wages (or labour) 7,50,000
Prime Cost 19,50,000
Factory Overheads (60% of wages) 4,50,000
Works Cost 24,00,000
Administration Overhead (20% of works cost) 4,80,000
Cost of Production 28,80,000
Selling & Distribution Overheads (40% i.e., 25 % + 15% of Works Cost) 9,60,000
Profit (1/5 of Total Cost) 7,68,000
Estimated Sales price 46,08,000
Illustration 4
A manufacturing company is divided into three production departments – A, B and C. All production
is to customers’ orders. All orders are dissimilar and they go through all the three departments.
Manufacturing Costs for a given period were as follows:
Particulars Dept A Dept B Dept C Total
Amount (`) Amount (`) Amount (`) Amount (`)
Direct material 1,80,000
Direct labour 40,000 20,000 30,000 90,000
Indirect manufacturing costs 20,000 40,000 30,000 90,000

COST ACCOUNTING
The cost of producing a particular order was determined as follows:

Direct material 1,000
Direct Labour: `
Department A 120
Department B 280
Department C 200 600
Indirect manufacturing Costs 600
2,200
The General Manager had a hazy idea that the jobs executed on orders of this nature are under-
priced. So, the services of a firm of cost accountants, of which you are a member, have been
acquired for a thorough investigation.
Can you detect, after a careful perusal of the limited available information, the fundamental
fallacy of the company’s method assuming that the direct labour cost is an acceptable basis for
distributing indirect manufacturing costs?
Prepare a revised cost for order distributing indirect manufacturing costs in a manner you consider more
correct than the company’s procedure.
Solution:
The predominant fault is the adoption of a blanket rate for the distribution of the indirect
manufacturing costs for all the three departments, i.e., 100% of total direct labour cost. This has
been done despite of the fact that there are glaring differences of the direct labour cost of three
departments. For calculating the revised cost of jobs, departmental rates based on indirect
manufacturing cost percentage to direct labour costs are calculated:
Particulars Departments
A B C
Indirect Mfg. Cost (`) (a) 20,000 40,000 30,000
Direct Labour (`) (b) 40,000 20,000 30,000
% of Mfg. Cost to Labour Cost [(a/b) x 50% 200% 100%
100]
On the assumption that direct labour cost method is considered to be a reasonable method of
absorption of overheads, it is quite possible that departmental application of overhead may be able
to resolve the difficulty faced by the manager regarding the costing of the job given. On this basis
the amended job cost sheet will be as under:
Revised Cost of Job
Direct Materials (Given) 1,000
Direct Labour:
Dept. A 120
Dept. B 280
Dept. C 200 600
1,600
Indirect Manufacturing Cost: (Revised)
Dept. A 50% of Direct Labour 60
Dept. B 200% of Direct Labour 560
Dept. C 100% of Direct Labour 200 820
Total Cost 2,420

Illustration 5
A shop floor supervisor of a small factory presented the following cost for Job no.555 to determine selling
price.
Particulars Per unit (`)

Materials 70
Direct Wages 18 hours at 2.5 45
Dept. X-8 hours
Dept. Y-6 hours
Dept. Z-4 hours
Chargeable expenses (special stores items) 5
120
Plus 33% Overheads 40
160
Analysis of the Profit/Loss Account for 2016 shows the following
Particulars Amount (`) Amount (`) Particulars Amount (`) Amount (`)
Materials 1,50,000 Sales 2,50,000
Direct Wages:
Dept. X 10,000
Dept. Y 12,000
Dept. Z 8,000 30,000
Special stores items 4,000
Overheads:
Dept. X 5,000
Dept. Y 9,000
Dept. Z 2,000 16,000
2,00,000
Gross profit c/d 50,000
2,50,000 Gross profit b/d 2,50,000
Selling expenses 20,000 50,000
Net profit c/d 30,000
50,000 50,000
It is also noted that average hourly rates for the 3 departments, X, Y and Z are similar.
You are required:
(a) Draw up a job cost sheet;
(b) Calculate the entire revised cost using 2016 actual figures as basis;
(c) Add 20% to total cost to determine selling price.

COST ACCOUNTING
Solution:
(a) Calculation of Departmental Overhead Rates
Amount (`)
Particulars Departments
X Y Z
(i) Direct Wages 10,000 12,000 8,000
(ii) Rate of wages per hour 2.5 2.5 2.5
(iii) Hours (i  ii) 4000 4800 3200
(iv) Actual Overheads 5000 9000 2000
(v) Department Overhead Rates per hour (iv  iii) 1.250 1.875 0.625
(b) Revised job cost sheet

Materials 70
Labour:
Dept. X 8 x 2.5 20
Dept. Y 6 x 2.5 15
Dept. Z 4 x 2.5 10 45
Direct Expenses 5
Prime Costs 120
Overheads:
Dept. X 8 x 1.250 10.00
Dept. Y 6 x 1.875 11.25
Dept. Z 4 x 0.625 2.50 23.75
Total Cost 143.75
(c)
Add: Profit 20% 28.75
Selling Price 172.50
Illustration 6
In a factory following the Job Costing Method, an abstract from the work in process as at 30th September,
was prepared as under.
Amount (`)
Job No. Materials Direct Labour Factory Overheads Applied

115 1,325 400 hrs 800 640
118 810 250 hrs. 500 400
120 765 300 hrs 475 380
2,900 1,775 1,420

Materials used in October were as follows:
Amount (`)
Material requisitions No. Job no. Cost

54 118 300
55 118 425
56 118 515
57 120 665
58 121 910
59 124 720
3,535
A summary of Labour Hours deployed during October is as under:
NUMBER OF HOURS
JOB NO.
SHOP A SHOP B
115 25 25
118 90 30
120 75 10
121 65 -
124 20 10
275 75
Indirect Labour:
Waiting for material 20 10
Machine breakdown 10 5
Idle time 5 6
Overtime premium 6 5
316 101
A shop credit slip was issued in October, that material issued under requisition No.54 was returned
back to stores as being not suitable. A material transfer note issued in October indicated that
material issued under requisition No.55 for Job 118 was directed to Job 124.
The hourly rate in shop A per labour hour is `3 while at shop B it is ` 2 per hour. The factory overhead is
applied at the same rate as in September; Jobs 115, 118 and 120 were completed in October.
You are asked to compute the factory cost of the completed jobs. It is practice of the management to
put a 10% on the factory cost to cover administration and selling overheads and invoice the job to the
customer on a total cost plus 20% basis what would be the invoice price of these three jobs?

COST ACCOUNTING
Solution:
Calculation of selling price of the Job
Job No. 115 118 120

Amount (`) Amount (`) Amount (`)
Costs in September:
Material 1,325 810 765
Labour 800 500 475
Overheads 640 400 380
Total (A) 2,765 1,710 1,620
Costs in October:
Material - 515 665
Labour
(25 x 3)+(25 x 2) 125
(90 x 3)+(30 x 2) 330
(75 x 3)+(10 x 2) 245
Overheads (80% of Labour) 100 264 196
Total (B) 225 1,109 1,106
Total Factory Cost (A+B) 2,990 2,819 2,726
Add: Admn. Overheads’ 10% 299.0 281.9 272.6
3,289.0 3,100.9 2,998.6
Profit 20% 651.80 620.18 599.72
Selling Price 3,946.80 3,721.08 3,598.32
5.2 BATCH COSTING
Meaning
Batch Costing is that form of specific order costing under which each batch is treated as a cost unit
and costs are accumulated and ascertained separately for each batch. Each batch consists of a
number of like units.
Basic Features
(a) Each batch is treated as a cost unit.
(b) All costs are accumulated and ascertained for each batch.
(c) A separate Batch Cost Sheet is used for each batch and is assigned a certain number by which
the batch is identified.
(d) The cost per unit is ascertained by dividing the total cost of a batch by the number of items
produced in that batch.
Applications
Batch Costing is applied in those industries where the similar articles are produced in definite
batches for internal consumption in the production of finished products or for sale to customers
generally. It is generally applied in –
(a) Read made Garments Manufacturing Industries

(b) Pharmaceutical/ Drug Industries
(c) Spare parts and Components Manufacturing Industries
(d) Toys Manufacturing Industries
(e) Tyre and Tubes Manufacturing Industries
Economic Batch Quantity (EBQ)

Meaning
Economic Batch Quantity refers to the optimum quantity batch which should be produced at a point
of time so that the Set up & Processing Costs and Carrying Costs are together optimized.
Setting up & Processing Costs
The setting up and processing costs refer to the costs incurred for setting up and processing
operations before the start of production of a batch. There is an inverse relationship between batch
size and set up & processing costs.
Large the Batch size : Lower the set up costs because of few batches
Smaller the Batch Size : Higher the set up costs because of more
batches Carrying Costs
The carrying costs refer to the costs incurred in maintaining a given level of inventory. There is
positive relationship between batch size and carrying costs.
Large the Batch size : Higher the carrying costs because of high average inventory
Smaller the Batch Size : Lower the carrying costs because of low average inventory
Trade off
The optimum quantity of batch which should be produced at a point of time determined after
achieving a trade off between set up costs and carrying costs. Such batch size is known as EBQ
because annual total cost of set up and carrying is minimum at this batch size.
FORMULA
2AS
E.B.Q =
C
Where, E.B.Q = Economic Batch Quantity

A = Annual Demand
S = Set up Cost per batch
C = Carrying Costs per unit per year
Illustration 7
From the following information, calculate Economic Batch Quantity for a company using batch costing:
Annual Demand for the components 2400 units

Setting up cost per batch ` 100
Manufacturing cost per unit ` 200
Carrying cost per unit 6% p.a.

COST ACCOUNTING
Solution :
2AS 2 × 2,400 ×
EBQ = = = 200 Units
C 100
6% of 200
Illustration 8
A customer has been ordering 90,000 special design metal columns at the columns at the rate of
18,000 per order during the past years. The production cost comprises `120 for material, ` 60 for labour
and ` 20 for fixed overheads. It costs ` 1,500 to set up for one run of 18,000 column and inventory
carrying cost is 15% since this customer may buy at least 5000 columns this year, the company
would like to avoid making five different production runs. Find the most economic production run.
Solution :
Economic Production Run
2 × Annual Output × Setup Cost Per Pr oduction

=
Run
Inventory Carrying Cost per unit p.a.
2 × 90,000 × 1,500
= = 3,000 units
15% of 200 (120 + 60 +
20)
Illustration 9
AB Ltd.is committed to supply 24,000 bearings per annum to CD Ltd. On a steady basis. It is
estimated that it costs 10 paise as inventory holding cost per bearing per month and that the set-up
cost per run of bearing manufacture is ` 324.
(a) What would be the optimum run size for bearing manufacture?
(b) What is the minimum inventory holding cost at optimum run size?
(c) Assuming that the company has a police of manufacturing 6000 bearing per run, how much
extra costs would the company be incurring as compared to the optimum run suggested in (a)?
Solution :
2AS
(a) Optimum production Run Size (Q) =
C
Where, A = No. of units to be produced within one year = 24,000 (units) bearing
O = Set-up cost per production run = ` 324
C = Carrying cost per unit per annum = 0.10 × 12 = ` 1.2
2 × 24,000 ×
= = 3,600 units (bearing)
324
1.2
(b) Minimum inventory Holding Cost, if run size is 3600 bearings
= Average inventory x carrying cost per unit
= ( 3600/2) x (.10 x 12) = ` 2160

(c) Statement showing Total Cost at Production Run sizes of 3600 and 6000 bearings
A. Annual requirements 24000 24000

B. Run size 3600 6000
C. No. of runs (A/B) 6.667 4
D. Set up cost per run ` 324 ` 324
E. Total set up cost (C X D) ` 2160 ` 1296
F. Average inventory( B/2) 1800 3000
G. Carrying cost per unit p.a. 1.20 1.20
H. Total carrying cost ( F x G) 2160 3600
I. Total cost (E + H) 4320 4896
Extra cost incurred , if run size is of 6000 = ` 4896 – ` 4320 = ` 576
Illustration 10
Component ‘Gold’ is made entirely in cost centre 100. Material cost is 6 paise per component and
each component takes 10 minutes to produce. The machine operator is paid 72 paise per hour, and
machine hour rate is ` 1.50. The setting up of the machine to produce the component ‘Gold’ takes
2 hours 20 minutes.
On the basis of this information, prepare a cost sheet showing the production and setting up cost,
both in total and per component, assuming that a batch of :
(a) 10 components,
(b) 100 components, and
(c) 1000 components is produced.
Solution :
Cost Sheet Component ‘Gold’ Amount (`)
Particulars Batch Size

10 components 100 components 1000 components
Total Per Total Per Total Per
component component component
A. Setting up Cost:
Machine Operators wages
(2 hours 20minutes @ `72 p.h) 1.68 0.168 1.68 0.0168 1.68 0.00168
Overheads 3.50 0.350 3.50 0.0350 3.50 0.00350
2 hours 20minutes @ `1.50 p.h)
B. Production Cost:
Material Cost @ `0. 06 per
component 0.60 0 .060 6.00 0.0600 60.00 0.06000
Machine Operators Wages 1.20 0.120 12.00 0.1200 120.00 0.12000
[(Refer to Working Note (i)]
Overheads
[(Refer to Working Note (ii)] 2.50 0.250 25.00 0.2500 250.00 0.25000
C. Total Cost : (A + B) 9.48 0.948 48.18 0.4818 43518 0.43518

COST ACCOUNTING
Working Notes:
10 100 1000 Components

Components Components
(i) Operators Wages
Time taken in minutes by
machine operators and machine
100 1000 10000
@10minutes per component
Operators Wages @ ` 0.72 per
hour (`) [100/60 x 0.72]=1.2 [1000/60 x 0.72]=12 [10000/60 x 0.72]=120
(ii) Overhead expenses 2.50 25.00 250.00
Total overhead expenses
@ ` 1.50 per Machine hour [100/60 x ` 1.50] [1000/60 x `1.50] [10000/60 x `1.50]
5.3 CONTRACT COSTING
Contract Costing or Terminal Costing as it is often termed, is a variant of the job costing system,
which is applied in businesses engaged in building or other construction work. The jobs are usually
the contracts entered into with the customers. As the number of such contracts handled at a time by
a business may not be usually large, Contract Costing is comparatively simpler in operation than job
costing system. The basic principles applied in Contract Costing are the same as those used in job
costing except that these are modified to suit the particular requirements of the contracts.
Differences between Job costing and Contract costing

(a) While the number of jobs in hand at any time in a concern may be large, only a few contracts
may be undertaken at a time.
(b) The accumulation, analysis, apportionment, allocation and control of costs is simplified in Contract
Costing.
(c) Most of the expenses are chargeable direct to the Contract Account. Direct allocation to
such an extent is not possible in job costing.
(d) As contracts may run for long periods, there arises the problem of assessment and crediting
of profits on incomplete contracts at the end of the accounting period.
Illustration 11
A firm of Builders, carrying out large contracts kept in contract ledger, separate accounts for each
contract on 30th June, 2017, the following were shown as being the expenditure in connection with
Contract No. 555.

Amount (`)
Materials purchased 1,16,126
Materials issued from stores 19,570
Plant, which has been used on other contracts 25,046
Additional plant 7,220
Wages 1,47,268
Direct expenses 4,052
Proportionate establishment expenses 17,440
The contract which had commenced on 1st February, 2017 was for ` 6,00,000 and the amount
certified by the Architect, after deduction of 20% retention money, was ` 2,41,600 the work being
certified on 30th June, 2017. The materials on site were ` 19,716. A contract plant ledger was also
kept in which depreciation was dealt with monthly the amount debited in respect of that account is `
2260. Prepare Contract Account showing profit on the contract.
Solution:
Dr. Contract Account Cr.
To, Materials purchased A/c 1,16,126 By, Work in progress A/c
To, Material issued A/c 19,570 - Work certified 3,02,000
To, Depreciation A/c 2,260
To, Wages A/c 1,47,268 By, Material stock A/c 19,716
To, Direct expenses A/c 4,052
To, Proportionate estab. expenses A/c 17,440
To, P & L A/c [15,000 x 2/3 x 4/5] 8,000
To, Reserve c/d 15,000
3,21,716 3,21,716
Illustration 12
A contractor has undertaken a construction work at a price of ` 5,00,000 and begun the execution of
work on 1st January, 2016. The following are the particulars of the contract up to 31st December, 2016.

Machinery 30,000 Overheads 8,252
Materials 1,70,698 Materials returned 1,098
Wages 1,48,750 Work certified 3,90,000
Direct expenses 6,334 Cash received 3,60,000
Uncertified work 9,000 Materials on 31.12.2016 3,766
Wages outstanding 5,380
Value of plant on 31.12. 2016 22,000

COST ACCOUNTING
It was decided that the profit made on the contract in the year should be arrived at by deducting the
cost of work certified from the total value of the architects certificate, that 1/3 of the profit so
arrived at should be regarded as a provision against contingencies and that such provision should be
increased by taking to the credit of Profit and Loss Account only such portion of the 2/3rd profit, as
the cash received to the work certified.
Solution:

To, Machinery A/c 30,000 By, Plant & Machinery A/c 22,000
To, Materials A/c 1,70,698 By, Materials returned A/c 1,098
To, Wages incl. outstanding A/c 1,54,130 By, Materials on hand A/c 3,766
To, Direct Expenses A/c 6,334 By, W.I.P A/c
To, Overheads A/c 8,252 Work certified 3,90,000
To, P & L A/c 34,738 Work uncertified 9,000 3,99,000
4,25,864 4,25,864
Illustration 13
A contractor commenced the work on a particular contract on 1st April, 2016 he usually closes his
books of accounts for the year on 31st December of each year. The following information is revealed
from his costing records on 31st December, 2016.
Amount (`)
Materials sent to site 43,000
Jr. Engineer 12,620
Labour 1,00,220
A machine costing ` 30,000 remained in use on site for 1/5th of year. Its working life was estimated at 5
years and scrap value at ` 2,000
A supervisor is paid ` 2,000 per month and had devoted one half of his time on the contract.
All other expenses were `14,000 the materials on site were ` 2,500.
The contract price was ` 4,00,000. On 31st December, 2016 2/3rd of the contract was completed
however, the architect gave certificate only for ` 2,00,000. On which 80% was paid. Prepare
Contract Account.

Solution:
Contract Account
Dr. Cr.

To, Material A/c 43,000 By, W.I.P A/c
To, Jr. Engineer A/c 12,620 Work certified 2,00,000 2,44,365
To, Labour A/c 1,00,220 Work uncertified *44,365
To, Dep. On plant A/c 1,120 By, Material at site 2,500
[(30,000-2,000)/5] x 1/5
To, Supervisor (2,000 x 9 x 1/2) 9,000
To, Other expenses A/c 14,000
To, P & L A/c 35,683
2,46,865 2,46,865
Working notes:
Work uncertified:
For 2/3rd - `1,77,460
For 1/6 th
-? (2/3 – 1/2 = 1/6)
* [(1,77,460 ÷ 2/3) x 1/6] = `44,365
Illustration 14
The following figures are supplied to you by contractor for the year ending 31st December, 2016.

Work-in-Progress on 31-12-2015 ` 85,000
Less: Cash received from contractee ` 55,000 30,000
During the year:
Wages 8,500
Materials bought 6,000
Working expenses 1,500
Materials issued from stores 10,500
Administrative expenses (`250 are chargeable to Profit and Loss Account) 1,250
Plant 2,500
Material returned to supplier 450
Material returned to stores 550
Work certified 15,000
Contracts finished 22,500
Profits taken upon contracts 11,500
Advances from contractee 40,000

COST ACCOUNTING
Prepare Contract Ledger Accounts, and the total contractee’s and show the work-in-progress as it
would appear in the Balance sheet.
Solution:
To, Work-in-Progress 85,000 By, W.I.P A/c
A/c To, Wages A/c 8,500 Work certified 15,000
To, Materials A/c 6,000 Work uncertified 88,000 1,03,000
To, Materials A/c 10,500 By, Material returned (supplier) 450
To, Working Expenses A/c 1,500 By, Material returned (stores) 550
To, Administration Expenses A/c 1,000 By, Contractee A/c 22,500
To, Plant 2,500
To, P & L A/c 11,500
1,26,500 1,26,500
Dr. Contractee Account Cr.

To, Contract A/c 22,500 By, Balance 55,000
To, Balance c/d 72,500 b/d By, Cash 40,000
A/c
95,000 95,000
Balance Sheet as on …….

Liabilities Amount (`) Assets Amount (`)
W.I.P 1,03,000
(-) Cash received 72,500 30,500
Illustration 15
The information given under has been extracted from the books of a contractor relating to contract
for `3,75,000.
I YEAR II YEAR III YEAR

Materials 45,000 55,000 31,500
Direct Expenses 1,750 6,250 2,250
Indirect expenses 750 1,000 ---
Wages 42,500 57,500 42,500
Total work certified 87,500 2,82,500 3,75,000
Uncertified work --- 5,000 ---
Plant 5,000 --- ---
The value of plant at the end of I year was `4,000 at the end of II year `2,500 and at the end of III
year it was `1,000. It is customary to pay 90% in cash of the amount of work certified. Prepare the
contract Account and show how the figures would appear in the balance sheet.
Solution:

Ist Year
To, Materials A/c 45,000 By, W.I.P A/c
To, Direct Expenses A/c 1,750 Work certified 87,500
To, Indirect Expenses A/c 750 Work uncertified Nil 87,500
To, Wages A/c 42,500 By, Plant A/c 4,000
To, Plant A/c 5,000 By, P & L A/c 3,500
95,000 95,000
IInd Year
To, Work in progress A/c 87,500 By, W.I.P A/c
To, Materials A/c 55,000 Work certified 2,82,500
To, Direct Expenses A/c 6,250 Work uncertified 5,000 2,87,500
To, Plant A/c 4,000 By, Plant A/c 2,500
To, Wages A/c 57,500
To, Indirect Expenses A/c 1,000
To, P & L A/c 47,250
2,90,000 2,90,000
IIIrd Year
To, Work in progress A/c 2,87,500 By, Reserve b/d 31,500
To, Plant A/c 2,500 By, Contractee A/c 3,75,000
To, Materials A/c 31,500 By, Plant A/c 1,000
To, Direct expenses 2,250
A/c To, Wages A/c 42,500
To, P & L A/c 41,250
4,07,500 4,07,500
Balance Sheet as on …….

Ist Year Work in progress 87,500
---- (-) Cash received (90%) 78,750 8,750
Plant 4,000
IInd Year Work in progress 2,87,500
---- (-) cash received (90%) 2,54,250
33,250
(-) Reserve 31,500 1,750
IIIrd Year ---- Plant 2,500

COST ACCOUNTING
Illustration 16
A firm of engineers undertook three contracts beginning on 1st Jan, 1st May and 1st August 2015. Their
accounts on 30th November, 2015 showed the following position:
Particulars Contract I Contract II Contract III

Contract price 80,000 54,000 60,000
Materials 14,400 11,600 4,000
Wages 22,000 22,500 2,800
General expenses 800 550 200
Cash received for
work certified 30,000 24,000 5,400
Work certified 40,000 32,000 7,200
Work uncertified 1,200 1,600 400
Wages outstanding 700 750 350
General expenses
outstanding 150 100 50
Plant installed 4,000 3,200 2,400
Materials on hand 800 800 400
On the respective dates of the contracts, the plant was installed depreciation thereon being taken at
15% p.a. You are required to prepare accounts in the Contract Ledger.
Solution:
Amount (`)
I II III I II III
To, Materials A/c 14,400 11,600 4,000 By, W.I.P A/c
To, Wages (incl. o/s) A/c 22,700 23,250 3,150 Work certified 40,000 32,000 7,200
To, Gen Expenses A/c 950 650 250 Work uncertified 1,200 1,600 400
To, Dep. On plant A/c 550 280 120 By, Material on hand A/c 800 800 400
(4,000 x 15% x 11/12) By, P & L A/c -- 1,380 --
(3,200 x 15% x 7/12)
(2,400 x 15% x 4/12)
To, Notional profit 3,400 -- 480
42,000 35,780 8,000 42,000 35,780 8,000
To, P & L A/c By, Notional profit 3,400 -- 480
(3,400 x 2/3 x 3/4) 1,700 -- --
To, Reserve c/d 1,700 -- 480
3,400 -- 480 3,400 -- 480

Illustration 17
The following is the Trial Balance of Premier Construction Company, engaged on the execution of
contract No.747, for the year ended 31st December, 2015.
Contractee’s Account Amount (`) Amount (`)

Amount received 3,00,000
Buildings 1,60,000
Creditors 72,000
Bank Balance 35,000
Capital Account 5,00,000
Materials 2,00,000
Wages 1,80,000
Expenses 47,000
Plant 2,50,000
8,72,000 8,72,000
The work on Contract No.747 was commenced on 1st January, 2015 materials costing ` 1,70,000
were sent to the site of the contract but those of ` 6,000 were destroyed in an accident. Wages of
`1,80,000 were paid during the year. Plant with a cost of ` 2 lakhs was used from 1st January to
30th September and was then returned to the stores. Materials of the cost of ` 4,000 were at site on
31st December, 2012.
The contract was for ` 6,00,000 and the contractee pays 75% of the work certified. Work certified
was 80% of the total contract work at the end of 2012. Uncertified work was estimated at ` 15,000
on 31st December, 2015.
Expenses are charged to the contract at 25% of wages. Plant is to be depreciated at 10% for the entire
year.
Solution:

To, Materials A/c 1,70,000 By, Costing P & L A/c 6,000
To, Wages A/c 1,80,000 By, Materials returned 4,000
By, W.I.P A/c 4,95,000
To, Dep. on plant A/c 20,000
Work certified 4,80,000
[2,50,000 x 9/12 x 10/100]
Work uncertified 15,000
[50,000 x 3/12 x 10/100]
To, Expenses (25%) 45,000
To, P & L A/c 45,000
5,05,000 5,05,000

COST ACCOUNTING
Dr. Profit & Loss Account Cr.

To, Contract A/c 6,000 By, Profit from Contract A/c 45,000
To, Dep. on Plant 5,000
[2,00,000 x 10% x 3/12]
To, Expenses (47,000 – 45,000) A/c 2,000
To, Net Profit 32,000
45,000 45,000
Balance Sheet as on …………

To, Capital A/c 5,00,000 By, W.I.P A/c 4,95,000
To, P & L A/c 32,000 (-) Cash received 3,00,000
To, Creditors A/c 72,000 1,95,000
(-) Reserve 45,000 1,50,000
By, Buildings A/c 1,60,000
By, Bank A/c 35,000
By, Material stock A/c 34,000
By, Plant A/c 2,25,000
6,04,000 6,04,000
Illustration 18
A company of builders took to a multi-storied structure for ` 40,00,000 estimating the cost to be `
36,80,000. At the end of the year, the company had received ` 14,40,000 being 90% of the work
certified; work done but not certified was `40,000. Following expenditure were incurred.
`
Materials 4,00,000
Labour 10,00,000
Plant 80,000
Materials costing ` 20,000 were damaged. Plant is considered as having depreciated at 25%.
Prepare Contract Account and show all the possible figures that can reasonably be credited to Profit
and Loss Account.
Solution:
To, Material 4,00,000 By, Costing P & L A/c 20,000
To, Labour 10,00,000 By, W.I.P A/c
To, Depreciation 20,000 Work certified 16,00,000
To, Notional Profit 2,40,000 Work uncertified 40,000 16,40,000
16,60,000 16,60,000
(i) 3,20,000 x (1,420/3,680) = 1,23,478
(ii) 3,20,000 x (1,420/3,680) x 90/100 = 1,11,130
(iii) 3,20,000 x 16/40 = 1,28,000
(iv) 3,20,000 x (16/40) x (90/100) = 1,15,200

Illustration 19
The following Trial Balance was extracted on 31st December, 2015 from the books of Swastik Co.
Ltd contractors: Amount (`)
Dr. Cr.
Share Capital:
Shares of `10 each 3,51,800
P&L A/c on 1.1. 2015 25,000
Provision for Dep. on Machinery 63,000
Cash received on account Contract - 7 12,80,000
Creditors 81,200
Land and Buildings (Cost) 74,000
Machinery (Cost) 52,000
Bank 45,000
Contract 7:
Materials 6,00,000
Expenses 40,000
Machinery on site (Cost) 1,60,000
18,01,000 18,01,000
Contract 7 was begun on 1st Jan 2015. The contract price is ` 24,00,000 and the customer has so
far paid ` 12,80,000 being 80% of the work certified.
The cost of the work done since certification is estimated at ` 16,000. On 31st December, 2015, after the
above Trial Balance was extracted machinery costing ` 32,000 was returned to stores, and materials
then on site were value at `27,000.
Provision is to be made for direct labour due `6,000 and for depreciation of all machinery at 12 1/2 %
on cost.
You are required to prepare:
(a) The Contract Account;
(b) A Statement of Profit, if any, to be properly credited to profit and loss account for 2015 and
(c) The Balance Sheet of Swastik Co. Ltd as on 31st December.
Solution:
To, Material A/c 6,00,000 By, W.I.P A/c
To, Direct labour A/c 8,36,000 Work certified 16,00,000 16,16,000
To, Expenses A/c 40,000 Work uncertified 16,000
To, Dep. on machinery A/c 20,000 By, Material at site A/c 27,000
To, P & L A/c 78,400
16,43,000 16,43,000

COST ACCOUNTING
Dr. Profit and Loss Account Cr.

To, Dep. on plant A/c 6,500 By, Balance b/d 25,000
To, Net profit 96,900 By, Profit from contract A/c 78,400
1,03,400 1,03,400
Balance Sheet as on …………

Share Capital 3,51,800 Machinery 2,12,000
P & L A/c 96,900 (-) Provision 63,000
Creditors 81,200 C.Year Depreciation 26,500 1,22,500
O/s Labour 6,000
W.I.P 16,16,000
(-) Cash received 12,80,000
3,36,000
(-) Reserve 68,600 2,67,400
Land & Buildings 74,000
Bank 45,000
Stock of materials 27,000
5,35,900 5,35,900
Illustration 20
Kapur Engineering Company undertakes long term contract which involves the fabrication of pre
stressed concrete block and the reaction of the same on consumer’s life.
The following information is supplied regarding the contract which is incomplete on 31st March, 2017
Cost Incurred: Amount (`)
Fabrication cost to date:
Direct materials 2,80,000
Direct Labour 90,000
Overheads 75,000
4,45,000
Erection cost to date 15,000
Total 4,60,000
Contract price 8,19,000
Cash received on account 6,00,000
Technical estimate of work completed to date:
Fabrication: Direct materials 80%
Direct labour and overheads 75%
Erection 25%
You are required to prepare a statement for submission to the management indicating
(a) The estimated profit on the completion of the contract;
(b) The estimated profit to date on the contract.

Solution:
Statement showing computation of profit on completion of contract and profit to date: Amount (`)
Particulars Incurred to To be Total

date incurred
Material 2,80,000 70,000 3,50,000
Labour 90,000 30,000 1,20,000
Overheads 75,000 25,000 1,00,000
Erection 15,000 45,000 60,000
4,60,000 1,70,000 6,30,000
Profit * * 1,89,000
Contract Price 8,19,000
Profit to date = 1,89,000 x (6,00,000 / 8,19,000) = 1,38,461 (or)

= 1,89,000 x (4,60,000 / 6,30,000) = 1,38,000
Illustration 21
The following particulars are obtained from the books of Vinay Construction Ltd. as on March, 2017.
`
Plant and equipment at cost 4,90,000
Vehicles at cost 2,00,000
Details of contract with remain uncompleted as on 31-3-2017.
Contract nos.
Particulars V.29 V.24 V.25
(`lacs) (`lacs) (`lacs)
Estimated final sales value 8.00 5.60 16.00
Estimated cost 6.40 7.00 12.00
Wages 2.40 2.00 1.20
Materials 1.00 1.10 0.44
Overheads (excluding dep.) 1.44 1.46 0.58
4.84 4.56 2.22
Value certified by architects 7.20 4.20 2.40
Progress payments received 5.00 3.20 2.00
Depreciation of plant and Equipment and Vehicle should be charged at 20% to the three contracts in
proportion to work certified. You are required to prepare statements showing contract-wise and
total.
(a) Profit/loss to be taken to the P & L A/c for the year ended 31st March, 2017.
(b) Work-in-progress as would appear in the Balance Sheet as at 31-03-2017.

COST ACCOUNTING
Solution:
(` in Lacs)
Particulars V.29 V.24 V.25 Particulars V.29 V.24 V.25
To, Expenses other than By, W.I.P A/c
depreciation 4.84 4.56 2.22 Work certified 7.20 4.20 2.40
To, Depreciation * 0.72 0.42 0.24 By, P & L A/c -- 0.78 0.06
To, Notional profit 1.64 -- --
7.20 4.98 2.46 7.20 4.98 2.46
To, P & L A/c *1.00 -- -- By Notional profit 1.64 -- --
To, Reserve A/c 0.64 -- --
1.64 -- -- 1.64 -- --
* V.29  [6,90,000 x 20% x 7.2/13.8] = 0.72 and similarly for V.24 & V.25 also.
Profit to be transfer to Profit and Loss A/c = EP x CR/CP = 1.60 x 5.00/8 =
1*
Illustration 22
A company is manufacturing building bricks and fire bricks. Both the products require two processes.
Brick forming and Heat treatment. The requirements for the two bricks are:
BUILDING BRICKS FIRE BRICKS
Forming per 100 bricks 3 hrs. 2 hrs.
Heat treatment per 100 bricks 2hrs. 5 hrs.
Total costs of the two departments in one month were:
Forming ` 21,200
Heat Treatment `48,800
Production during the month was:
Building Bricks 1,30,000 Nos.
Fire Bricks 70,000 Nos.
Prepare statement of manufacturing costs for the two varieties of bricks.
Solution:
Statement Showing Number of Hours
Particulars Buil. Bricks Fire Bricks Total
Forming
(1,30,000/100) x 3 3,900 1,400 5,300
(70,000/100) x 2
Heat treatment 2,600 3,500 6,100
(1,30,000/100) x 2
(70,000/100) x 5
Total 6,500 4,900 11,400
Cost of forming per hour = 21,200 / 5,300 = 4

Cost of Heat treatment per hour = 48,800 / 6,100 = 8

COST ACCOUNTING
Statement showing computation of manufacturing cost per two varieties of bricks: Amount (`)
Particulars Buil. Bricks Fire Bricks Total
Forming
(3,900 x 4), (1,400 x 4) 15,600 5,600 21,200
Heat treatment 20,800 28,000 48,800
(2,600 x 8), (3,500 x 8)
Total 36,400 33,600 70,000
Illustration 23
Deluxe limited undertook a contract for `5,00,000 on 1st July, 2016. On 30th June 2017 when the
accounts were closed, the following details about the contract were gathered:

Materials purchased 1,00,000
Wages paid 45,000
General expenses 10,000
Plant Purchased 50,000
Materials on hand 30-6-2017 25,000
Wages accrued 30-6-2017 5,000
Work certified 2,00,000
Cash received 1,50,000
Depreciation of Plant 5,000
Work uncertified 15,000
The above contract contained an escalator clause which read as follows:

“In the event of prices of materials and rates of wages increase by more than 5% the contract price
would be increased accordingly by 25% of the rise in the cost of materials and wages beyond 5% in
each case”.
It was found that since the date of signing the agreement the prices of materials and wage rates
increased by 25% the value of the work certify does not take into account the effect of the above clause.
Prepare the contract account. Working should form part of the answer.
Solution:
Cost of material & wages incurred = ` (1,00,000 + 45,000 + 5,000 – 25,000 )
= `1,25,000
Cost of material & wages before increase in prices = ` (1,25,000 x 100/125 )
= `1,00,000
Increase in contract price = `25/100 [1,25,000 – ` (1,00,000 x 105/100)]
= `5,000 *

To, Material purchased A/c 1,00,000 By, Material on hand 25,000
To, Wages A/c 50,000 Work certified 2,05,000 2,20,000
To, General Expenses A/c 10,000 Work uncertified 15,000
To, Depreciation on plant 5,000
To, P & L A/c 19,512
2,45,000 2,45,000
5.4 PROCESS COSTING – JOINT & BY-PRODUCTS
Process Costing
Process costing is that aspect of operation costing which is used to ascertain the cost of the product
at each process or stage of manufacture. This method of accounting used in industries where the
process of manufacture is divided into two or more processes. The objective is to find out the total
cost of the process and the unit cost of the process for each and every process. Usually the
industries where process costing used are textile, oil industries, cement, pharmaceutical etc.
Features of Process Costing
(a) Production is done having a continuous flow of products having a continuous flow of identical
products except where plant and machinery is shut down for repairs etc.
(b) Clearly defined process cost centres and the accumulation of all costs by the cost centres.
(c) The maintenance of accurate records of units and part units produced and cost incurred by each
process.
(d) The finished product of one process becomes the raw material of the next process or operation
and so on until the final product is obtained.
(e) Avoidable and unavoidable losses usually arise at different stages of manufacture for various
reasons.
(f) In order to obtain accurate average costs, it is necessary to measure the production at various
stages of manufacture as all the input units may not be converted into finished goods.
(g) Different products with or without by-products are simultaneously produced at one or more
stages or processes of manufacture. The valuation of by-products and apportionment of joint
cost before joint of separation is an important aspect of this method of costing.
(h) Output is uniform and all units are exactly identical during one or more processes. So the cost
per unit of production can be ascertained only by averaging the expenditure incurred during a
particular period.
Applications of Process Costing
The industries in which process costs may be used are many. In fact a process costing system can
usually be devised in all industries except where job, batch or unit or operation costing is necessary.
In particular, the following are examples of industries where process costing is applied:
Chemical works Textile, weaving, spinning etc.
Soap making Food products
Box making Canning factory
Distillation process Coke works
Paper mills Paint, ink and varnishing etc.
Biscuit works Meat products factory
Oil refining Milk dairy

COST ACCOUNTING
Difference between Job Costing and Process Costing:

Job Costing Process Costing
(i) The form of specific order costing which That form of costing which applies where
applies where the work is undertaken to standardised goods are produced and
customer’s special requirements. production is in continuous flow, the products
being homogeneous.
(ii) The job is the cost unit and costs are collected Costs are collected by process or
for each job. department on time basis and divided by
output for a period to get an average cost per
unit.
(iii) Losses are generally not segregated. Normal losses are carefully predetermined and
abnormal losses are segregated.
(iv) Overheads are allocated and apportioned to Units pass through the same processes.
cost centres then absorbed by jobs, in Overheades are apportioned to processes
proportion to the time taken. on some suitable basis, some times, pre-
detarmined rates may be used
(v) Joint products / By-products do not usually Joint products/By-products do arise and joint
arise in jobbing work. cost apportionment is necessary.
(vi) Standard costing is generally not suitable for The standardised nature of products and
jobbing work. processing methods lends itself to the
adoption of standard costing.
(vii) Work-in-progress valuation is specific and is For WIP valuation operating costs have to
obtained from analysis of outstanding jobs. be spread over fully complete output and
partially complete products using the
concept of equivalent units.
(viii) Each job is separate and independent of Products lose their individual identity as they
others. Costs are computed when a job is are manufactured in a continuous flow.
complete. Costs are calculated at the end of cost
period.
(ix) There are usually no transfers from one job to Transfer of costs from one process to another is
another unless there is a surplus work or made, as the product moves from one
excess production. process to another.
(x) There may or may not be work-in-progress at There is always some work-in-process at
the beginning or end of the accounting period. the beginning as well as at the end of the
accounting period.
(xi) Proper control is comparatively difficult as Proper control is comparatively easier, as the
each product unit is different and the production is standardised and is more stable.
production is not continuous.
(xii) It requires more forms and details. It requires few forms and less details.

Abnormal loss (or gain) = Total Loss – Normal Loss
The valuation of abnormal loss should be done with the help of this formula:
(Normal Cost of Normal Output)
Value of Abnormal Loss = x Units of Abnormal Loss
(Normal Output)
Joint and By-Products
Meaning of Joint Products
In CIMA Terminology defines joint products as “two or more products separated in the course of
processing each having a sufficiently high value to merit recognition as a main product”. Joint
products imply that they are produced from the same basic raw material, are comparatively of equal
importance, are produced simultaneously by a common process and may require further processing
after the point of separation.
Difference Between Joint products and Co-products
Joint products are frequently confused with co-products. However, there is significant difference
between the two, the former being indivisible and the latter divisible. Common costs are allocable
among products or services performed because each of the products or services could have been
obtained separately. Therefore, any shared cost of obtaining them can be meaningfully allocated on
the basis of relative usage of the common facilities. For example, the cost of fuel or power may be
allocated to products based on production volumes and metered usage. Co-products do not always
arise from the same operation or raw materials and the quantity of co-products is within the control
of manufacturer. Thus different quantities of car, jeep and trucks can be produced in car
manufacturing industry according to the need of the concern.
Features of Joint Products
(a) Joint products are the result of utilization of the same raw material and same processing
operations. The processing of a particular raw material may result into the output of two or
more products.
(b) All the products emerging from the manufacturing process are of the same economic
importance. In other words, the sales value of those products may be more or less same and
none of them can be termed as the major product.
(c) The products are produced intentionally which implies that the management of the concerned
organization has intention to produce all the products.
(d) Some of joint products may require further processing or may be sold directly after the split off point.
(e) The manufacturing process and raw material requirement is common up to a certain stage of
manufacturing. After the stage is crossed, further processing becomes different for each
product. This stage is known as ‘split off’ point. The expenditure incurred up to the split off
point is called as

COST ACCOUNTING
joint cost and the apportionment of the same to different products is the main objective of the
joint product accounting.
(f) The management has little or no control over the relative quantities of the various products that
will result.
(g) Joint products are commonly produced in industries like, chemicals, oil refining, mining,
meatpacking, automobile etc. In oil refining, fuel, oil, petrol, diesel, kerosene, lubricating oil are
few examples of the joint products.
Accounting for Joint Product Cost

Before we proceed to discuss the methods of accounting in case of joint products and by-products, it
will be necessary to understand certain terms clearly. These terms are explained below:
(i) Split Off Point: This is a point up to which, input factors are commonly used for production of
multiple products, which can be either joint products or by-products. After this point, the joint
products or byproducts gain individual identity. In other words, up to a certain stage, the
manufacturing process is the same for all the products and a stage comes after which, the
individual processing becomes different and distinct. For example, in a dairy, several products
like, milk, ghee, butter, milk powder, ice-cream etc. may be produced. The common material is
milk. The pasteurization of milk is a common process for all the products and after this process;
each product has to be processed separately. This point is of special significance in the
accounting of joint product and by-products because the joint cost incurred before this point is
to be apportioned appropriately in the joint products.
(ii) Joint Costs: Joint cost is the pre separation cost of commonly used input factors for the production
of multiple products. In other words, all costs incurred before or up to the split off point are
termed as joint costs or pre separation costs and the apportionment of these costs is the main
objective of joint product accounting. Costs incurred after the split off point are post separation
costs and can be easily identified with the products.
Accounting Treatment
In case of joint products, the main objective of accounting of the cost is to apportion the joint
costs incurred up to the split off point. As discussed earlier, the manufacturing process is same up to
a certain stage and after crossing that stage; each product has distinct manufacturing process.
Therefore the main problem is apportionment of the joint cost or the cost incurred up to the split off
point. The total cost of production of the joint product will be cost incurred up to the split off point
duly apportioned plus the cost incurred after the split off point. There is no problem of charging the
cost incurred after the split off point as the cost can be identified easily. The main problem therefore
is that of apportionment of the joint cost and the following methods are used for apportioning the
same.
(i) Physical Quantity Method: Under this method, cost apportionment is made in proportion to the
volume of production. These physical measures may be units, pounds, liters, kilos, tones,
gallons etc.
(ii) Average Unit Cost Method: Under this method, the joint cost is apportioned to the joint products
by computing the average unit cost of the product units. The average unit cost is computed by
dividing the total manufacturing cost by the total number of units produced of all products. This
method is useful where all the products produced are uniform with each other in all the
respects. This method will not be useful if the production units are not similar with each other.
(iii) Weighted Average Method: Under this method, weights are assigned to each unit based
upon size of the units, difference in type of labor employed, material consumption, market
share, efforts of labour required and so on. The joint cost is apportioned on the basis of the
weights assigned to each product. This method is highly useful if the weights assigned are on

objective basis. If subjective element creeps in, the method may not give accurate results.

COST ACCOUNTING
(iv) Selling Price Method: Under this method, the joint cost is apportioned on the basis of sales value
at the split off point. The logic is that a product should bear the share of the joint cost
according to its sale price. If sales price is higher than that of the other products, more share of
joint cost should be charged to that product and if it is comparatively less than that of other
products, less share of joint cost should be charged to the same. Though logically this method
seems to be sound, in practice, charging higher share of joint cost to the product with higher
sales value may not be justified due to the fact that lesser efforts are required for
manufacturing of the same.
Meaning of By-Products
The term ‘by-products’ is sometimes used synonymously with the term ‘minor products’. The by-product
is a secondary product, which incidentally results from the manufacture of a main product. By–
products are also produced from the same raw material and same process operations but they are
secondary results of operation. The main difference between the joint product and byproduct is that
there is no intention to produce the by-product while the joint products are produced intentionally.
The relationship between the by-product and the main product changes with changes in economic or
industrial conditions or with advancement of science. The by-product of an industry may become a
main product and main product may become a by-product subsequently.
For example, (a) in sugar industry, sugar is a main product and molasses is a by-product (b) in coke
ovens, gas and tar are incidentally produced in addition to the main product coke. Gas and tar are,
therefore, treated as by-products. These minor secondary products have saleable or usable value
and are incidentally produced in addition to the main product.
In CIMA Terminology, By-product is “a product which is recovered incidentally from the material used
in the manufacture of recognized main products such as having either a net realizable value or a
usable value which is relatively low in comparison with the saleable value of the main products. By
products may further be processed to increase their realizable value”.
Thus the term ‘by-product’ is generally used by businessmen and accountants to denote one or more
products of relatively small value that are produced simultaneously with a product of greater value.
Classification of By-Products
By-products can be classified into two groups according to marketable conditions at the split off point:
(a) Those sold in the same form as originally produced, and
(b) Those which may undergo further processing before sale.
Accounting treatment
By-products are jointly produced products of minor importance and do not have separate costs until
the split off point. They are not produced intentionally but are emerging out of the manufacturing
process of the main products. The following methods are used for accounting of by-products. The
methods are broadly divided into Non-Cost Methods and Cost Methods.
(A) Non-Cost Methods: The following methods are included in this category.
(i) Other income or miscellaneous income method: Under this method, sales value of by-products
is credited to the Profit and Loss Account and no credit is given in the Cost Accounts. The
credit to the Profit and Loss Account is treated as other income or miscellaneous income.
No effort is made for ascertaining the cost of the product. No valuation of inventory is
made and all costs and expenses are charged to the main product. This is the least
scientific method and is used where the sales value of the by-product is negligible.
(ii) Total sales less total cost: Under this method, sales value of by-product is added to the
sales value of the main product. Further the total cost of the main product including the
cost of the by-product is deducted from the sales revenue of the main product and by-

product. All costs and expenses are charged to the main product.

COST ACCOUNTING
(iii) Total cost less sales value of by-product: In this method, the total cost of production is
reduced by the sales value of the by-product. This method seems to be more acceptable
because like waste and scrap, by-product revenue reduces the cost of major products.
(iv) Total cost less sales value of by-products after setting off selling and distribution overheads
of by-products: Sales value of the by-product minus the selling and distribution overheads of
byproduct is deducted from the total cost. Selling and distribution overheads are charged
against by-products actually sold.
(v) Reverse cost method: This method is based on the view that the sales value of the by-
product contains an element of profit. It is agreed that this element of profit should not be
credited to the Profit and Loss Account. The cost of by-product is arrived at by working
backwards. Selling price of the by-product is deflated by an assumed gross profit margin.
Thus under this method, sales value of the by-product is first reduced by, an estimated
profit margin, selling and distribution expenses and then the post split off costs and then
the cost of the main product is thus reduced by this net figure.
(B) Cost Methods: The following methods are included in this category.
(i) Replacement or opportunity cost method: If the by-products are consumed captively, they
are valued at the opportunity cost method or replacement cost method. This means the
cost which would have been incurred had the by-product been purchased from outside. For
example, bagasse, which is one of the main by-product of sugar industry and which is used
for the factory as a fuel in the boiler is valued at the market value, i.e. the price that would
have been paid if it would have been purchased from outside.
(ii) Standard cost method: Under this method, the by-product is valued at the standard cost
determined for each product. The standard cost may be based on technical assessment.
Standard cost of the by-product is credited to the process account of the main product.
Accordingly, the cost control of main product can be exercised effectively.
(iii) Joint cost proration: Where the by-product is of some significance, it is appropriate that the
joint costs should be apportioned between the main products and by-products on a most
suitable and acceptable method. Thus in this method, no distinction is made between the
joint product and byproduct. Industries, where the by-products are quite important, use
this method. For example, in a petroleum refinery, gas was earlier considered as a by-
product. Now it has assumed the importance like petrol, diesel etc. and is being treated as
joint product. Accordingly, the joint cost is prorated between the joint product and the by-
product.
Difference between Main product & Joint and By-Products

It is very difficult to make distinction between the joint products, main products and by-products.
There are, however, two checks which may be applied to determine if a product is a by-product or a
joint product or a main product:
(i) Value: If one of the products is of considerably large value than the others it will usually be
considered the main product. Conversely any product which is of considerably less value is likely
to be classified as a by-product. If both or some or all the products are more or less of equal
value, they are likely to be classified as joint products.
(ii) Manufacturing objective: If the company’s objective is to produce A, then B, C and D
produced simultaneously will be classified as by-products. This is independent of the comparative
values of the various products. If the objective is to produce A and B, they become joint
products and C and D become by-products. For example, in coke oven, the objective being
production of coke, this is considered as the main product, and gas and tar as by-products.

There are instances when a by-product attains so much importance in terms of sales value and/or
the company objective, then it is regarded as a main product. There are also instances when a by-
product is more important than the main product, so that they by-product becomes the main
product and the main product becomes the by-product.
Illustration 34
X, Y Ltd. manufactures product A which yields two by-products B and C. The actual joint expenses of
manufacturing for a period were ` 8,200.
The profits on each product as a percentage of sales are 33-1/3%, 25% and 15% respectively.
Subsequent expenses are as follows:
Products Amount (`)
Particulars ‘A’ ‘B’ ‘C’

Material 100 75 25
Direct 200 125 50
Overheads 150 125 75
450 325 150
Sales 6,000 4,000 2,500
Apportion the joint expenses
Solution:
Statement Showing Apportionment of Joint Expenses
Particulars A B C Total
Sales 6,000 4,000 2,500 12,500
(-) Profit 2,000 1,000 375 3,375
Total Cost (Joint & Separate cost) 4,000 3,000 2,125 9,125
Separate Expenses 450 325 150 925
Share of Joint Expenses 3,550 2,675 1,975 8,200
Illustration 35
A chemical process yields 60% of the material introduced as main Product - A and by Product B 15%
by - Product - C 20% and 5% being the wastage.
The ratio of absorption of Raw material and Labour in the process products is as follows :
(i) One unit of product C requires half the raw material required for one unit of product - B, one unit
of product - A requires 1 ½ time the raw material required for product - B.
(ii) Product A requires double the time needed for the production of one unit of B and one unit of C
(iii) Product C requires half the time required for the production of one unit of product B
(iv) Overheads are to be absorbed in the ratio of 6:1:1
(v) Cost Data: Input 1,000 units of cost `4,600
Direct labour `4,100
Overheads `6,000
Calculate cost of distribution between the above products.

COST ACCOUNTING
Solution:
A = 1,000 x 60% = 600 units
B = 1,000 x 15% = 150 units
C = 1,000 x 20% = 200 units
Wasteage = 1,000 x 5% = 50 units
Statement showing apportionment of Joint Cost
Element Basis of Total Main By Product B By Product C

Apportionment Product A
Material 18:3:2 4,600 3,600 600 400
Labour 36:3:2 4,100 3,600 300 200
Overheads 6:1:1 6,000 4,500 750 750
14,700 11,700 1,650 1,350
Material:
A : B : C = 3 x 600 : 2 x 150 : 1 x 200
= 1800 : 300 : 200
= 18 : 3 : 2
Labour:
A : B : C = 6 x 600 : 2 x 150 : 1 x 200
= 3600 : 300 : 200
= 36 : 3 : 2

Illustration 37
A factory engaged in the production of Chemical X and in the course of manufacture in a by-
product-Y is produced which after a separate process has a commercial value. Following are the
information for the month of March.
JOINT EXPENSES SEPARATE EXPENSES

X Y
Materials (`) 10,000 2,000 2,800
Labour (`) 4,000 2,500 2,500
Overheads (`) 2,500 1,400 1,000
The output for the month was 150 quintals of
1 X and 50 quintals of Y. The selling price of product Y is ` 200
per quintal. The profit on product Y is 33 % on cost price. Prepare an Account to show the cost of X
per quintal. 3
Solution:
Joint Expenses Account

Dr. Cr.
To, Material 10,000 By, Y A/c 1,200
To, Labour 4,000 By, X’s A/c 15,300
To, Overheads 2,500
16,500 16,500
X’s Account
Dr. Cr.
To, Material 2,000 By, Cost of production A/c
@ 141.33 per quintal.
To, Mabour 2,500 21,200
To, Overheads 1,400
To, Joint expenses A/c * 15,300
21,200 21,200

COST ACCOUNTING
Y’s Account
Dr. Cr.
To, Material 2,800 By, Cost of production A/c.
To, Labour 2,500 (150 x 50) 7,500
To, Overheads 1,000
To, Joint expenses A/c 1,200
7,500 7,500
Illustration 38
In manufacturing the main product ‘A’ a company processes the resulting waste material into two by
products B and C. Using reversal cost method of by products, prepare a comparative profit and loss
statement of the three products from the following data:
(i) Total cost upto separation point was ` 68,000 Amount (`)
A B C
(ii) Sales (all production) 1,64,000 16,000 24,000
(iii) Estimated net profit
% to sale value — 20% 30%
(iv) Estimated Selling expenses as
% of sales value 20% 20% 20%
(v) Costs after separation — 4,800 7,200
Solution:
Apportionment of Joint expenses for the products Amount (`)
Particulars B C
Sales 16,000 24,000
(-) Profit 3,200 7,200
Total Cost 12,800 16,800
(-) Selling expenses 3,200 4,800
Manufacturing cost 9,600 12,000
(-) Separate expenses 4,800 7,200
Joint Expenses 4,800 4,800
Joint expenses of A = 68,000 – (4,800 + 4,800) = 58,400.
Profit and Loss Statement Amount (`)
Particulars A B C Total
(i) Joint cost 58,400 4,800 4,800 68,000
(ii) Separate cost -- 4,800 7,200 12,000
(iii) Manufacturing cost (I + II) 58,400 9,600 12,000 80,000
(iv) Selling expenses 32,800 3,200 4,800 40,800
(v) Total cost (III + IV) 91,200 12,800 16,800 1,20,800
(vi) Profit * 72,800 3,200 7,200 83,200
(vii) Sales 1,64,000 16,000 24,000 2,04,000

Illustration 39
The progressive manufacturing company manufactures one main product and two by-products. Data
for month are shown below:
Particulars Main Product By-Product A By Product B

Sales 1,50,000 12,000 7,000
MANUFACTURING COST:
(a) Before separation 75,000 — —-
(b) After separation 23,000 2,200 1,800
Administration cost 12,000 1,500 1,000
Ratio of Distribution of
Selling cost 85% 10% 5%
Net profit in sales 20% 15% 10%
Assuming no beginning and ending inventories, apportion the joint cost among main product and the
byproducts.
Solution:
Calculation of Selling Expenses

Sales of 3 products 1,69,000
(-) Profit (30,000 + 1,800 + 700) (32,500)
Total Cost 1,36,500
(-) Joint & Separate cost (75,000 + 27,000) (1,02,000)
34,500
(-) Administration cost 14,500
Selling Expenses 20,000
Statement showing apportionment of Joint Expenditure
Particulars Main Product By Product A By Product B Total

(i) Sales 1,50,000 12,000 7,000 1,69,000
(ii) Profit 30,000 1,800 700 32,500
(iii) Total cost (i – ii) 1,20,000 10,200 6,300 1,36,500
(iv) Selling expenses 17,000 (85%) 2,000 1,000 20,000
(10%) (5%)
(v) Cost of production 1,03,000 8,200 5,300 1,16,500
(vi) Administration cost 12,000 1,500 1,000 14,500
(vii) Manufacturing cost (V-VI) 91,000 6,700 4,300 1,02,000
(viii) Separate expenses 23,000 2,200 1,800 27,000
(ix) Share of joint expenses (VII – VIII) 68,000 4,500 2,500 75,000

COST ACCOUNTING
Illustration 40
In a factory producing joint products of two varieties, the following data are extracted from the books:
TOTAL (`)
Sales of products X and Y 7,50,000
Direct Material 2,25,000
Variable Overhead (150% on Labour) 1,65,000
Fixed Overhead 2,00,000
2
The analysis of sales reveals that the percentage of sale of product X is 66 3 %.
Management contemplates to process further joint products so that they could be sold at higher
rates. Facilities for this are available. The additional expenditure for the further process and total
sales anticipated at higher selling prices are given below. Make recommendations presenting the
affect of the proposal.
PRODUCT X PRODUCT Y TOTAL

Sales after further processing 6,00,000 3,00,000 9,00,000
Additional material 50,000 20,000 70,000
Additional direct labour 20,000 8,000 28,000
Solution:
Amount (`)
Particulars X Y Total
(i) Sales after further processing 6,00,000 3,00,000 9,00,000
(ii) Sales at split off 5,00,000 2,50,000 7,50,000
(iii) Incremental sales 1,00,000 50,000 1,50,000
(iv) Incremental/Additional/further processing /
Separate cost:
Material 50,000 20,000 70,000
Labour 20,000 8,000 28,000
Variable Overheads 30,000 12,000 42,000
(v) Incremental Profit/Loss -- 10,000 10,000
It is recommended to further process Product Y because there is an incremental / additional profit
` 10,000 where as product X need not be further processed because there is no additional profit.
Illustration 41
A vegetable oil refining company obtains four products whose cost details are:
Joint costs of the four products: ` 8,29,600
Outputs : A - 5,00,000 litres; B -10,000 litres,C- 5,000 litres and D- 9,000 kgs.
Further processing costs: A ` 2,40,000; B ` 48,000, C-Nil and D-` 8,030.

The products can be sold as intermediates i.e., at split-off point without further processing. The sale
prices are:
As finished Product As Intermediate
A ` Per litre 1.84 1.20
B ` Per litre 8.00 4.00
C ` per litre 6.40 6.40
D ` Per Kg. 26.67 24.00
(a) Calculate the product-wise profit allocating joint costs on Net Realisable Values (NRV).
(b) Compare the profitability in selling the products with and without further processing.
Solution:
(a) Statement showing computation of profit after further processing Amount (`)
Particulars A B C D Total
(i) Sales after further processing 9,20,000 80,000 32,000 2,40,030 12,72,030
(ii) Separate / further costs 2,40,000 48,000 -- 8,030 2,96,030
(iii) Sales at split off
(being NRV) (I-II) 6,80,000 32,000 32,000 2,32,000 9,76,000
(iv) Joint costs (NRV basis) 5,78,000 27,200 27,200 1,97,200 8,29,600
(v) Profit 1,02,000 4,800 4,800 34,800 1,46,400
Statement Showing Computation of Profit Before Further Processing Amount (`)
(I) Sales at split off 6,00,000 40,000 32,000 2,16,000 8,88,000
(II) Joint costs as apportioned above 5,78,000 27,200 27,200 1,97,200 8,29,600
(III) Profit (I – II) 22,000 12,800 4,800 18,800 58,400
(b) Statement Showing Computation of Incremental or Additional Profit by Further Process Amount (`)
(I) Sales after further processing 9,20,000 80,000 32,000 2,40,030 12,72,030
(II) Sales before further processing 6,00,000 40,000 32,000 2,16,000 8,88,000
(III) Incremental or additional sales (I-II) 3,20,000 40,000 - 24,030 3,84,030
(IV) Incremental cost 2,40,000 48,000 - 8,030 2,96,030
(III) Additional Profit or Loss (III-IV) 80,000 (8,000) - 16,000 88,000
Products A&D should be further process, because there is incremental profit and where as products
B and C need not be further process.

COST ACCOUNTING
Alternative Method:
Statement Showing Computation of Profit Before Further Processing (on the basis of sales)
Amount (`)
(I) Sales before further processing/split off 6,00,000 40,000 32,000 2,16,000 8,88,000
(II) Joint costs 8,29,000 x (6,00,000/8,88,000) 5,60,540 37,369 29,895 2,01,796 8,29,600
(III) Profit 39,460 2,631 2,105 14,204 58,400
Statement Showing Computation of Profit After Further Processing (on basis of sales)
Amount (`)
(I) Sales at split off 6,80,000 32,000 32,000 2,32,000 9,76,000
(II) Joint costs as apportioned above. 5,60,540 37,369 29,895 2,01,796 8,29,600
(III) Profit or Loss 1,19,460 (5,369) 2,105 30,204 1,46,400
Illustration 42
T Ltd., in the course of refining crude oil obtains four joint products A, B, C and D. The total cost till the
split off point was ` 97,600. The output and sales in the year 2015 were as follows:
Product Output Sales Separate Costs

(Balance) Amount (`) Amount (`)
A 5,00,000 1,15,000 30,000
B 10,000 10,000 6,000
C 5,000 4,000 —
D 9,000 30,000 1,000
You are required:

(a) Calculate the net income for each of the products if the joint costs are apportioned on the basis
of sales value of the different products.
(b) What would be the net income of the company from each product if it decides to sell the products
at the split off point itself A@ `15 paise, B @ ` 50 paise, C @ ` 80 paise and D @ ` 3 per gallon.
(c) In case the company expects to operate at the same level of production and sales in the year
2012 could the company increase the net income by altering its processing decisions? If so,
what would be the expected overall net income? Which product should be sold at split off?
Assume that all costs incurred after the split -off are variable.

Solution:
Statement Showing Computation of Profit After Further Processing: Amount (`)
(I) Sales at further processing 1,15,000 10,000 4,000 30,000 1,59,000
(II) Separate cost 30,000 6,000 -- 1,000 37,000
(III) Sales at Split off (I) - (II) 85,000 4,000 4,000 29,000 1,22,000
(IV) Joint Costs (On basis of NRV) 68,000 3,200 3,200 23,200 97,600
(V) Profit (III) - (IV) 17,000 800 800 5,800 24,400
Statement Showing Computation of Profit Before Further Processing: Amount (`)

(I) Sales at split off 75,000 5,000 4,000 27,000 1,11,000
(II) Joint Cost (as apportioned above) 68,000 3,200 3,200 23,200 97,600
(III) Profit (I) - (II) 7,000 1,800 800 3,800 13,400
Statement Showing Computation Of Incremental Profit By Further Processing Amount (`)

(I) Sales after further process 1,15,000 10,000 4,000 30,000 1,59,000
(II) Sales at split off (I) - (II) 75,000 5,000 4,000 27,000 1,11,000
(III) Incremental sales 40,000 5,000 -- 3,000 48,000
(IV) Incremental/Separate costs 30,000 6,000 -- 1,000 37,000
(V) Incremental Profit (loss) (III) - (IV) 10,000 (1,000) -- 2,000 11,000
Product ‘A’ and ‘D’ should be further processed because there is additional profit where as
product ‘B’ and ‘C’ need not be further processed because there is no additional profit.
Computation of Profit by implementing decision:
Amount (`)
Profit from A = 17,000
Profit from B = 1,800
Profit from C = 800
Profit from D = 5,800
= 25,400
Illustration 43
Beauty soap, company manufactures four different brands of soaps namely Komal, Lovely, Makeup
and Nice. The data on production and sale of these brands during 2015 is reproduced below.
Brand Name Komal Lovely Makeup Nice

Production & Sales (units) 3,00,000 5,00,000 70,000 40,000
Sale value (` Lakhs) 15 31 2.8 1.2
All the above soaps are manufactured jointly up to a particular process. At split off point they are
formed into cake-sand packed. The annual cost data were as under.

COST ACCOUNTING
Direct Material Cost ` 30 lakhs

Value added ` 20 lakhs
(includes profit at 25% on total cost)
Out of the above brands, Make up is sold in unpacked condition without further processing while
other 3 brands further processed at an additional cost:
Komal `1,20,000
Lovely `1,30,000 and
Nice ` 50,000
You are required to:-
(a) Work out the profit and cost of each brand of soap after allocating joint cost on the basis of Net
Realisable value at split up point. (per unit cost not required).
(b) Find out revised cost and profit on each brand if the company decides to sell all soaps at split
up point at following prices; Komal ` 4.50; Lovely `6.00; Make up ` 4.00 and Nice ` 1.50 per unit.
Assume that for allocation of joint cost net Realisable value method is used.
(c) With the working results in (a) and (b) above advise Beauty Soap Company about the
processing decision as to which soap to ;be sold at split of point and which to be processed
further so as to maximise profit. Substantiate your decision with suitable costing technique.
Solution:
Computation of Joint Cost

Direct material 30,00,000
(+) value added 20,00,000
Total Sales 50,00,000
(-) Profit @ 25% on cost (i.e. 20% on sales) 10,00,000
(-) Separate Cost (120 + 130 + 50) 3,00,000
Joint Cost 37,00,000
Statement Showing Computation of Profit After Further Processing Amount (`)
Particulars K L M N Total
(I) Sales after further processing 15,00,000 31,00,000 2,80,000 1,20,000 50,00,000
(II) Separate cost 1,20,000 1,30,000 - 50,000 3,00,000
(III) Sales before further processing NRV= 13,80,000 29,70,000 2,80,000 70,000 47,00,000
(I-II)
(IV) Joint Costs (on basis of NRV) 10,86,383 23,38,085 2,20,426 55,106 37,00,000
(V) Profit or Loss (III-IV) 2,93,617 6,31,915 59,574 14,894 10,00,000

Statement Showing Computation of Profit Before Further Processing Amount (`)
(I) Sales at split off 13,50,000 30,00,000 2,80,000 60,000 46,90,000
(II) Joint Cost (as apportioned above) 10,86,383 23,38,085 2,20,426 55,106 37,00,000
(III) Profit or Loss 2,63,617 6,61,915 59,574 4,894 9,90,000
Statement Showing Computation of Incremental Profit By Further Processing Amount (`)

(I) Sales after further process 15,00,000 31,00,000 2,80,000 1,20,000 50,00,000
(II) Sales before further process 13,50,000 30,00,000 2,80,000 60,000 46,90,000
(III) Incremental sales (I-II) 1,50,000 1,00,000 - 60,000 3,10,000
(IV) Separate costs 1,20,000 1,30,000 - 50,000 3,00,000
(V) Incremental Profit (loss) (III-IV) 30,000 (30,000) - 10,000 10,000
Products K and N are to be further Process and whereas Products L and M need not to be further process
Illustration 44
In the course of manufacture of the main product ‘P’ by products ‘A’ and ‘B’ also emerge. The
joint expenses of manufacture amount to ` 1,19,550. All the three products are processed
further after separation and sold as per details given below:
Main product By products
P A B
Sales 90,000 60,000 40,000
Cost incurred after separation 6,000 5,000 4,000
Profit as percentage on sales 25 20 15
Total fixed selling expenses are 10% of total cost of sales which are apportioned to the three
products in the ratio of 20 : 40 : 40.
(a) Prepare a statement showing the apportionment of joint costs to the main product and the two
by products.
(b) If the by-product A is not subjected to further processing and is sold the point of separation for
which there is a market, at `58,500 without incurring any selling expenses. Would you advise its
disposal at this stage. Show the workings.
Solution:
(a) Statement showing computation of share of joint expenses Amount (`)
Particulars Main Product P By Product A By Product B Total
(i) Sales 90,000 60,000 40,000 1,90,000
(ii) Profit 22,500 12,000 6,000 40,500
(iii) Cost of sales (I - II) 67,500 48,000 34,000 1,49,500
(iv) Selling expenses 2,990 5,980 5,980 14,950
(v) Manufacturing cost (III - IV) 64,510 42,020 28,020 1,34,550
(vi) Separate costs 6,000 5,000 4,000 15,000
(vii) Share of joint expenses (V – VI) 58,510 37,020 24,020 1,19,550

COST ACCOUNTING
Amount (`)
Sales at split off (A) = 58,500
(-) Joint Cost (A) = 37,020
= 21,480
(b) It is better to sell By-Product ‘A’ at split off point because it gives more profit ` 21,480 against profit
after processing ` 12,000.
Illustration 45
“If the products are truly joint products the cost of the process can be applied to these products”.
(i) On the basis of the weight or other physical quantity of each product.
(ii) In respect of the marginal cost of the process on the basis of physical quantities and in respect
of fixed costs of the process on the basis of the contribution made by the various products.
(iii) On the basis of selling values of the different products
Illustrate the above statement by using the following figures in respect of joint production of A and B
for a month.
TOTAL COST: Direct Material 5,000
Direct labour 3,000
Variable Overheads 2,000
Fixed Overheads 2,000
Sales ——— A 100 Qtls. ` 80 per qtl
Sales ——— B 150 Qtls. ` 40 per qtl
Solution:
Computation of Profit by Distributing Joint Costs on the basis of Weight
Amount (`)
Particulars A B Total
(i) Sales 8,000 6,000 14,000
(ii) Costs (100 : 150) 4,800 7,200 12,000
(iii) Profit / (Loss) 3,200 (1,200) 2,000
Computation of Profit by Distributing Variable Cost on the Basis of Weight & Fixed Cost on basis of
Contribution Amount (`)
(i) Sales 8,000 6,000 14,000
(ii) Variable costs (100 : 150) 4,000 6,000 10,000
(iii) Contribution 4,000 -- 4,000
(iv) Fixed cost 2,000 -- 2,000
(v) Profit 2,000 -- 2,000

Computation of Profit by distribution on the basis of Sales : Amount (`)
(i) Sales 8,000 6,000 14,000
(ii) Total cost 6,857 5,143 12,000
(iii) Profit 1,143 857 2,000

COST ACCOUNTING

Study Note - 6
COST ACCOUNTING TECHNIQUES
6.1 Marginal Costing

6.2 Standard Costing & Variance Analysis
6.3 Budget and Budgetary Control
6.1 MARGINAL COSTING
Marginal Cost is defined as “the amount at any given volume of output by which aggregate costs are
changed if the volume of output is increased or decreased by one unit.” Marginal Cost also
means Prime Cost plus Variable Overheads. Marginal Cost also means Prime Cost plus Variable
Overheads. Marginal Cost is a constant ratio which may be expressed in terms of an amount per unit
of output. On the other hand, fixed cost which is not normally traceable to particular unit denotes a
fixed amount of expenditure incurred during an accounting period. Fixed cost is, therefore, also
called time cost, period cost, standby cost, capacity cost, or constant cost. Variable cost or marginal
cost is also termed as direct cost, activity cost, volume cost or out-of-pocket cost.
From the above definition and analysis of marginal cost, we can understand that is the cost which
varies according to the variations in the volumes of output. However, by definition marginal cost is the
change in the total cost for addition of one unit. It is to be noted that for an economist marginal
cost and variable cost would be different. But for an accountant both marginal cost and variable
cost are same and are interchangeably used. Therefore, for our study, we use marginal cost and
variable cost synonymously.
Marginal costing is “the ascertainment of marginal costs and of the effect on profit of changes in
volume or type of output by differentiating between fixed costs and variable costs.” Several other
terms in use like direct costing, contributory costing, variable costing, comparative costing, differential
costing and incremental costing are used more or less synonymously with marginal costing.
It is a process whereby costs are classified into fixed and variable and with such a division so many
managerial decisions are taken. The essential feature of marginal costing is division of total costs into
fixed and variable, without which this could not have existed. Variable costs vary with volume of
production or output, whereas fixed costs remains unchanged irrespective of changes in the volume
of output. It is to be understood that unit variable cost remains same at different levels of output
and total variable cost changes in direct proportion with the number of units. On the other hand,
total fixed cost remains same disregard of changes in units, while there is inverse relationship
between the fixed cost per unit and the number of units.
Features of Marginal Costing

The main features of Marginal Costing may be summed up as follows:
1. Appropriate and accurate division of total cost into fixed and variable by picking out variable
portion of semi variable costs also.
2. Valuation of stocks such as finished goods, work-in-progress is valued at variable cost only.

COST ACCOUNTING
3. The fixed costs are written off soon after they are incurred and do not find place in product cost
or inventories.
4. Prices are based on Marginal Cost and Marginal Contribution.
5. It combines the techniques of cost recording and cost reporting.
Advantages or Merits or Applications of Marginal Costing

1. Marginal costing system is simple to operate than absorption costing because they do not
involve the problems of overhead apportionment and recovery.
2. Marginal costing avoids, the difficulties of having to explain the purpose and basis of overhead
absorption to management that accompany absorption costing. Fluctuations in profit are easier
to explain because they result from cost volume interactions and not from changes in inventory
valuation.
3. It is easier to make decisions on the basis of marginal cost presentations, e.g., marginal costing
shows which products are making a contribution and which are failing to cover their avoidable
(i.e., variable) costs. Under absorption costing the relevant information is difficult to gather, and
there is the added danger that management may be misled by reliance on unit costs that
contain an element of fixed cost.
4. Marginal costing is essentially useful to management as a technique in cost analysis and
cost presentation. It enables the presentation of data in a manner useful to different levels of
management for the purpose of controlling costs. Therefore, it is an important technique in cost
control.
5. Future profit planning of the business enterprises can well be carried out by marginal costing.
The contribution ratio and marginal cost ratios are very useful to ascertain the changes in
selling price, variable cost etc. Thus, marginal costing is greatly helpful in profit planning.
6. When a business concern consists of several units and produces several products and
evaluation of performance of such components can well be made with the help of marginal
costing.
7. It is helpful in forecasting.
8. When there are different products, the determination of number of units of each product, called
Optimum Product Mix, is made with the help of marginal costing.
9. Similarly, optimum sales mix i.e., sales of each and every product to get maximum profit can also
be determined with the help of marginal costing.
10. Apart from the above, numerous managerial decisions can be taken with the help of
marginal costing, some of which, may be as follows:-
(a) Make or buy decisions,
(b) Exploring foreign markets,
(c) Accept an order or not,
(d) Determination of selling price in different conditions,
(e) Replace one product with some other product,
(f) Optimum utilisation of labour or machine hours,
(g) Evaluation of alternative choices,
(h) Subcontract some of the production processes or not,
Cost Accounting Techniques
(i) Expand the business or not,

(j) Diversification,
(k) Shutdown or continue,
Limitations of Marginal Costing

a. The separation of costs into fixed and variable present’s technical difficulties and no variable
cost is completely variable nor is a fixed cost completely fixed.
b. Under the marginal cost system, stock of finished goods and work-in-progress are understated.
After all, fixed costs are incurred in order to manufacture products and as such, these should
form a part of the cost of the products. It is, therefore, not correct to eliminate fixed costs from
finished stock and work-in-progress.
c. The exclusion of fixed overhead from the inventories affects the Profit and Loss Account
and produces an unrealistic and conservative Balance Sheet, unless adjustments are made
in the financial accounts at the end of the period.
d. In marginal costing system, marginal contribution and profits increase or decrease with changes
in sales volume. Where sales are seasonal, profits fluctuate from period to period. Monthly
operating statements under the marginal costing system will not, therefore, be as realistic or
useful as in absorption costing.
e. During the earlier stages of a period of recession, the low profits or increase in losses, as
revealed in a magnified way in the marginal costs statements, may unduly create panic and
compel the management to take action that may lead to further depression of the market.
f. Marginal costing does not give full information. For example, increased production and sales
may be due to extensive use of existing equipments (by working overtime or in shifts), or by an
expansion of the resources, or by the replacement of labour force by machines. The marginal
contribution fails to reveal these.
g. Though for short-term assessment of profitability marginal costs may be useful, long term profit is
correctly determined on full costs basis only.
h. Although marginal costing eliminates the difficulties involved in the apportionment and under
and over-absorption of fixed overhead, the problem still remains so far as the variable overhead
is concerned.
i. With increased automation and technological developments, the impact on fixed costs on
products is much more than that of variable costs. A system which ignores fixed costs is
therefore, less effective because a major portion of the cost, such as not taken care of.
j. Marginal costing does not provide any standard for the evaluation of performance. A system of
budgetary control and standard costing provides more effective control than that obtained
by marginal costing.
Absorption Costing
In absorption costing the classification of expenses is based on functional basis but in marginal
costing it is based on the nature of expenses. In absorption costing, the fixed expenses are
distributed over products based on a pre-determined level of output. Since fixed expenses are
constant, such a method of recovery will lead to over or under-recovery of expenses depending on
the actual output being greater or lesser than the estimate used for recovery. This difficulty will not
arise in marginal costing because the contribution is used as a resource for meeting fixed expenses.

COST ACCOUNTING
The presentation of information to management under the two costing techniques is given below.
Income Statement (Absorption costing)
Particulars (`) (`)

Sales -----
Production Costs:
Direct material consumed -----
Direct labour cost -----
Variable manufacturing overhead ------
Fixed manufacturing overhead ------
Cost of production ------
Add: Opening stock of finished goods ------
(Value at cost of previous period’s production) ------
Less: Closing stock of finished goods ------

(Value at production cost of current period ------
Cost of Goods Sold -------
Add: (or less) Under (or over) absorption of Fixed ------
Manufacturing overhead
Add: Administration costs -------
Add: Selling and distribution costs ------- --------
Total Cost ----------
Profit (Sales – Total cost) ----------
Income Statement (Marginal costing)

Particulars (`)
Sales -----
Variable manufacturing costs:
- Direct material consumed -----
- Direct labour -----
- Variable manufacturing overhead ------
Cost of Goods Produced -----
Add: Opening stock of finished goods -----
(Value at cost of previous period)
Less: Closing stock of finished goods
(Value at current variable cost ) -----
Cost of Goods Sold -----
Add: Variable administration, Selling and distribution overhead -----
Total Variable Cost ------
Add: Selling and distribution costs -----
Contribution (Sale – Total variable costs) -----
Less: Fixed costs (production, admin, selling and dist.) -----
Net profit -----

It is observed from the above that under marginal costing technique the contributions of various
products are pooled together and the fixed overheads are met out of such total contribution. The
total contribution is also known as gross margin. The contribution minus fixed expenses gives net profit.
Limitations of Absorption Costing

1. Being dependent on levels of output which vary from period to period, costs are vitiated due to
the existence of fixed overhead. This renders them useless for purposes of comparison and
control. (If, however, overhead recovery rate is based on normal capacity, this situation will not
arise).
2. Carryover of a portion of fixed costs, i.e., period costs to subsequent accounting periods as part
of the cost of inventory is a unsound practice because costs pertaining to a period should not be
allowed to be vitiated by the inclusion of costs pertaining to the previous period.
3. Profits and losses in the accounts are related not only to sales but also to production, including
the production which is unsold. This is contrary to the principle that profits are made not at the
stage when products are manufactured but only when they are sold.
4. There is no uniformity in the methods of application of overhead in absorption costing. These
problems have, no doubt, to be faced in the case of marginal costing also but to a less extent
because of the exclusion of fixed costs, as different assumptions made in the matter of
application of fixed overhead will not arise in the case of marginal costing.
5. Absorption costing is not always suitable for decision making solutions to various types of
problems of management decision making, where the absorption cost method would be
practically ineffective, such as selection of production volume and optimum capacity utilisation,
selection of production mix, whether to buy or manufacture, choice of alternatives and
evaluation of performance can be had with the help of marginal cost analysis. Sometimes, the
conclusion drawn from absorption cost data in this regard may be misleading and lead to losses.
Differences between Absorption Costing and Marginal Costing
Absorption Costing Marginal Costing

1. Both fixed and variable costs are considered Only variable costs are considered for product
for product costing and inventory valuation. costing and inventory valuation.
2. Fixed costs are charged to the cost of Fixed costs are regarded as period costs. The
production. Each product bears a profitability of different products is judged by
reasonable share of fixed cost and thus the their P/V ratio.
profitability of a product is influenced by the
apportionment of fixed costs.
3. Cost data are presented in conventional Cost data are presented to highlight the total
pattern. Net profit of each product is contribution of each product.
determined after subtracting fixed cost along
with their variable cost.
4. The difference in the magnitude of opening The difference in the magnitude of opening
stock and closing stock affects the unit cost stock and closing stock does not affect the
of production due to the impact of related unit cost of production.
fixed cost.
5. In case of absorption costing the cost per In case of marginal costing the cost per unit
unit reduces, as the production increases as it remains the same, irrespective of the
is fixed cost which reduces, whereas, the production as it is valued at variable cost.
variable cost remains the same per unit.

COST ACCOUNTING
Difference in profit under Marginal and Absorption Costing

• No opening and closing stock: In this case, profit/loss under absorption and marginal costing will
be equal.
• When opening stock is equal to closing stock: In this case, profit/loss under two approaches will
be equal provided the fixed cost element in both the stocks is same amount.
• When closing stock is more than opening stock: In other words, when production during a
period is more than sales, then profit as per absorption approach will be more than that by
marginal approach. The reason behind this difference is that a part of fixed overhead included
in closing stock value is carried forward to next accounting period.
• When opening stock is more than the closing stock: In other words when production is less
than the sales, profit shown by marginal costing will be more than that shown by absorption
costing. This is because a part of fixed cost from the preceding period is added to the current
year’s cost of goods sold in the form of opening stock.
Illustration 1
MAXWEL Ltd. produces a single product Boost. The following figures relate to Boost for the period: 2017-
2018.
Activity Level 50% 100%

Sales and production (units) 400 800
(`) (`)
Sales 8,00,000 16,00,000
Production costs:
- Variable 3,20,000 6,40,000
- Fixed 1,60,000 1,60,000
Selling and distribution costs:
- Variable 1,60,000 3,20,000
- Fixed 2,40,000 2,40,000
The normal level of activity for the year is 800 units. Fixed costs are incurred evenly throughout the year,
and actual fixed costs are the same as budgeted. There were no stocks of Boost at the beginning of
the year.
In the first quarter, 220 units were produced and 160 units were sold.
Required:
(a) What would be the fixed production costs absorbed by Boost if absorption costing is followed?
(b) What would be the under/over-recovery of overheads during the period?
(c) What would be the profit as per absorption costing?
(d) What would be the profit as per marginal costing?

Solution:
Fixed production costs absorbed
Particulars (`)
Budgeted fixed production costs 1,60,000
Budgeted output (normal level of activity 800 units)
Therefore, the absorption rate: 1,60,000/800 = ` 200 per unit
During the first quarter, the fixed production cost absorbed by Boost 44,000
would be (220 units × ` 200)
Under/over-recovery of overheads during the period
Particulars (`)
Actual fixed production overhead (1/4 of ` 1,60,000) 40,000
Absorbed fixed production overhead 44,000
Over-recovery of overheads 4,000
Profit for the Quarter (Absorption Costing)
Particulars (`) (`)

Sales revenue (160 units × ` 2,000): (A) 3,20,000
Less: Production costs:
- Variable cost (220 units × ` 800) 1,76,000
- Fixed overheads absorbed (220 units × ` 200) 44,000 2,20,000
Add: Opening Stock -----
Less: Closing Stock (` 2,20,000/220 units × 60 units) (60,000)
Cost of Goods sold 1,60,000
Less: Adjustment for over-absorption of fixed production overheads (4,000)
Less: Selling & Distribution Overheads:
-Variable (160 units × ` 400) 64,000
- Fixed (1/4 of ` 2,40,000)
th
60,000 1,24,000
Cost of Sales (B) 2,80,000
Profit {(A) – (B)} 40,000
Profit for the Quarter (Marginal Costing)
Particulars (`) (`)

Sales revenue (160 units × ` 2,000): (A) 3,20,000
Less: Production costs:
- Variable cost (220 units × ` 800) 1,76,000
Add: Opening Stock -----
Less: Closing Stock (` 1,76,000/220 units × 60 units) (48,000)

COST ACCOUNTING
Variable cost of goods sold 1,28,000

Add: Selling & Distribution Overheads:
-Variable (160 units × Rs.400) 64,000
Cost of Sales (B) 1,92,000
Contribution {(C) = (A) – (B)} 1,28,000
Less: Fixed Costs:
- Production cost (40,000)
- Selling & distribution cost (60,000) (1,00,000)
Profit 28,000
Differential Cost Analysis

Differential Cost is the change in the costs which results from the adoption of an alternative course
of action.
The essential features of differential costs are as follows:-

1. The basis data used for differential cost analysis are costs, revenue and the investment factors
which are relevant in the problem for which the analysis is undertaken.
2. Total differential costs rather than the costs per unit are considered.
3. Differential cost analysis is made outside the accounting records.
4. As the differences in the costs at two levels are considered, absolute costs at each level are not
as relevant as the difference between the two. Thus, items of costs which do not change but
are identical for the alternatives under consideration, are ignored.
5. The differentials are measured from a common base point or position.
6. The stage at which the difference between the revenue and the cost is the highest, measured
from the common base point, determines the choice from amongst a number of alternative
actions.
7. In computing differential costs, historical or standard costs may be used but they should be
adjusted to the requirements of future conditions.
8. The elements and items of cost to be considered in differential cost analysis will depend upon
the nature of the problem and the alternatives being considered.

Differential Costs Analysis and Marginal Costing

Although the techniques of differential costs analysis are similar to those of marginal costing, the
two should not be confused. The points of similarity and difference between differential costs
analysis and marginal costing are summarized below:
Similarity
a. Both the techniques of cost analysis and cost presentation.
b. Both are made use of by the management in decision making and in formulating policies.
c. The concepts of differential costs and marginal costs mainly arise out of the difference in the
behaviour of fixed and variable costs.
d. Differential costs compare favourably with the economist’s definition of marginal cost, viz. that
marginal cost is the amount which at any given volume of output is changed if output is
increased or decreased by one unit.
Difference
a. Differential cost analysis can be made in the case of both absorption costing as well as marginal
costing.
b. While marginal costing excludes the entire fixed costs, some of the fixed costs may be taken into
account as being relevant for the purpose of differential cost analysis.
c. Marginal costs may be embodied in the accounting system whereas differential costs are
worked out separately as analysis statements.
d. In marginal costing, margin of contribution and contribution ratio are the main yardsticks for
performance evaluation and for decision making. In differential cost analysis, differential costs
are compared with the incremental or decremental revenues, as the case may be.
Practical Application of Differential Costs

They are useful in managerial decisions, which are enumerated below:
(i) Determination of most profitable levels of production and price
(ii) Acceptance of offer at a lower price or offering a quotation at lower selling price in order
to increase capacity
(iii) It is used to decide whether it will be more profitable to sell a product as it is or to process it further
into a different product to be sold at an increased price
(iv) Determining the suitable price at which raw material may be purchased
(v) Decision of adding a new product or business segment
(vi) Discontinuing a product or business segment in order to avoid or reduce the present loss or increase
profit
(vii) Changing the product mix
(viii) Make or buy decisions
(ix) Decision regarding alternative capital investment and plant replacement
(x) Decision regarding change in method of production

COST ACCOUNTING
Tools and Techniques of Marginal Costing

1. Contribution

Proof for basic breakeven

Let, V be the variable cost per unit
U be the volume of output i.e., No. of units
P be the Profit
F be the Fixed Cost
S be the Selling
Price
By substituting the notations in general sales equation:
Sales = Fixed cost + Variable cost + Profit
SU = F + VU + P
At Break Even, SU = F +VU (Since P = 0)
 SU – VU = F
 U(S – V) = F
F
U= S -
V
OR
Fixed Cost
No. of Units Contributionper Unit
=
Break even sales
FS
SU (Sales) 
SV
Uses and applications of Break even Analysis (Or) Profit Charts (Or) Cost Volume Profit Analysis
The important uses to which cost-volume profit analysis or break-even analysis or profit charts may be
put to use are:
a. Forecasting costs and profits as a result of change in Volume determination of costs, revenue and
variable cost per unit at various levels of output
b. Fixation of sales Volume level to earn or cover given revenue, return on capital employed, or
rate of dividend
c. Determination of effect of change in Volume due to plant expansion or acceptance of order,
with or without increase in costs or in other words, determination of the quantum of profit to be
obtained with increased or decreased volume of sales
d. Determination of comparative profitability of each product line, project or profit plan
e. Suggestion for shift in sales mix
f. Determination of optimum sales volume
g. Evaluating the effect of reduction or increase in price, or price differentiation in different markets
h. Highlighting the impact of increase or decrease in fixed and variable costs on profit
i. Studying the effect of costs having a high proportion of fixed costs and low variable costs and
vice-versa
COST ACCOUNTING
j. Inter-firm comparison of profitability

k. Determination of sale price which would give a desired profit for break-even
l. Determination of the cash requirements as a desired volume of output, with the help of cash
breakeven charts
m. Break-even analysis emphasizes the importance of capacity utilization for achieving economy.
n. During severe recession, the comparative effects of a shutdown or continued operation at a loss
are indicated.
o. The effect on total cost of a change in the fixed overhead is more clearly demonstrated through
break-even charts.
Margin of Safety-

COST ACCOUNTING
Illustration 2
ABC Ltd. incurs fixed costs of ` 3,00,000 per annum. It is a single product company with annual
sales budgeted to be 70,000 units at a sales price of ` 300 per unit. Variable costs are ` 285 per
unit.
The company is deliberating upon an increase in the selling price of the product to ` 350 per unit. This
shall be required in order to improve the quality of the product. It is anticipated that despite increase
in the selling price the sales volume shall remain unaffected. However, the fixed costs shall increase to
` 450,000 per annum and the variable costs to ` 330 per unit.
You are required to draw a profit volume graph, and determine the breakeven point. Also draw on
the same graph a second profit volume graph and give your comments.
Situation (ii)
Breakeven point
(i)
Profit Situation (i)
0
Loss
Number of units
Breakeven point (ii)
Workings:
The profit for sales of 70,000 units is ` 7,50,000
Particulars (` 000)
Contribution 70,000 × (` 300 – ` 285) 1050
Fixed Costs 300
Profit 750
This point is joined to the loss at zero activity, ` 3,00,000 i.e., the fixed costs. The profit
for sales of 70,000 units is ` 9,50,000
Particulars (` 000)
Contribution 70,000 × (` 300 – ` 330) 1400
Fixed Costs 450
Profit 950
This point is joined to the loss at zero activity, ` 4,50,000 i.e., the fixed costs.
Comments:
It is clear from the graph that there are larger profits available from option (ii). It also shows an increase
in the break-even point from 20,000 units to 22,500 units. However, the increase of 2,500 units may not
be considered large in view of the projected sales volume. It is worth-mentioning that for sales volumes
above 30,000 units the profit achieved will be higher with option (ii). For sales volumes below 30,000
units option (i) will yield higher profits (or lower losses).
Use of CVP Analysis in Decision Making

CVP analysis is used as an evaluation tool for managerial decisions. Therefore, let us discuss the
decision making framework. In the framework of decision making the following steps are to be taken
into consideration.
Step 1 : Identification of Problem
Step 2 : Identification of Alternatives
Step 3 : Evaluation of the Alternatives
Step 4 : Selection of the Best Alternative
Principles for Identification of Cost and Benefits for measurement

The cost and benefit of an alternative is identified for measurement if it satisfies the following principles:
Controllability: The costs and benefits which are controllable are considered for measurement for
making decision.
Relevance: The costs which are controllable need to be relevant for decision making. Thus, a cost is
relevant only if (i) it is a future cost and (ii) it differs under two alternatives under consideration.
Principles for Estimation of Costs and Benefits

After identification of the costs and benefits, it is needed to be measured and estimated. The estimation
is done by the two principles viz. (a) variability and (b) traceability.
Short-term Decision making using concepts of CVP Analysis

Management uses marginal costing and CVP concepts for making various decisions. Generally, short-
term decisions are related with temporary gaps between demand and supply for available resources.
The areas of short term decision are classified into two broad categories:
(i) Decision related with excess supply, such as:
(a) Processing of Special Order
(b) Determination of price for stimulating demand
(c) Local vs Export sale
(d) Determination of minimum price for price quotations
(e) Shut-down or continue decision etc.
(ii) Decision related with excess demand, such as:

(a) Make or Buy/ In-house-processing vs Outsourcing
(b) Product mix decision under resource constraints (limiting factors)
(c) Sales mix decisions
(d) Sale or further processing etc.

COST ACCOUNTING
Illustration 3
The sports material manufacturing company budgeted the following data for the coming year.
Amount (`)
Sales (1,00,000 units) 1,00,000
Variable cost 40,000
Fixed cost 50,000
Find out
(a) P/V Ratio, B.E.P and Margin of Safety
(b) Evaluate the effect of
(i) 20% increase in physical sales volume
(ii) 20% decrease in physical sales volume
(iii) 5% increase in variable costs
(iv) 5% decrease in variable costs
(v) 10% increase in fixed costs
(vi) 10% decrease in fixed costs
(vii) 10% decreases in selling price and 10% increase in sales volume
(viii) 10% increase in selling price and 10% decrease in sales volume
(ix) ` 5,000 variable cost decrease accompanied by ` 15,000 increase in fixed costs.
Solution:
(a) P/V ratio, B.E.P and Margin of Safety
Contribution = Sales – Variable cost
= 1,00,000 – 40,000
= ` 60,000
P/V Ratio = (Contribution / Sales) x 100
= (60,000 / 1,00,000) x 100
= 60%
B.E.P sales = Fixed cost / PV ratio
= 50,000 / 60%
= ` 83,333
Margin of Safety = Total sales – B.E.P sales
= 1,00,000 – 83,333
= `16,667

(b) Amount (`)
Contribution P/V ratio BE Sales Margin of safety

(i) Increase in volume by 1,20,000 – 48,000 (72,000 / 1,20,000) x 100 (50,000 / 60%) 1,20,000 – 83,333
20% = 72,000 = 60% = 83,333 = 36,667
(ii) Decrease in volume by 80,000 – 32,000 (48,000 / 80,000) x 100 (50,000 / 60%) 80,000 – 83,333
20% = 48,000 = 60% = 83,333 = (3,333)
(iii) 5% increase in variable 1,00,000 – 42,000 (58,000 / 1,00,000) x 100 (50,000 / 58%) 1,00,000 – 86,207
cost = 58,000 = 58% = 86,207 = 13,793
(iv) 5% decrease in variable 1,00,000 – 38,000 (62,000 / 1,00,000) x100 (50,000 / 62%) 1,00,000 – 80,645
cost = 62,000 = 62% = 80,645 = 19,355
(v) 10% increase in fixed 1,00,000 – 40,000 (60,000 / 1,00,000) x 100 (55,000 / 60%) 1,00,000 – 91,667
cost = 60,000 = 60% = 91,667 = 8,333
(vi) 10% decrease in fixed 1,00,000 – 40,000 (60,000 / 1,00,000) x 100 (45,000 / 60%) 1,00,000 – 75,000
costs = 60,000 = 60% = 75,000 = 25,000
(vii) 10% decreases in selling 99,000 – 44,000 (55,000 / 99,000) x 100 (50,000 / 99,000 – 90,009
price and 10% increase = 55,000 = 55.55% 55.55%) = 8,991
in sales volume = 90,009
(viii) 10% increase in selling 99,000 – 36,000 (63,000 / 99,000) x 100 (50,000 / 99,000 – 78,579
price and 10% = 63,000 = 63.63% 63.63%) = 20,421
decrease = 78,579
in sales volume
(ix) ` 5,000 variable cost 1,00,000 – 35,000 (65,000/1,00,000) x 100 (65,000 / 65%) 1,00,000 –
decrease accompanied = 65,000 = 65% = 1,00,000 1,00,000
by ` 15,000 increase in =0
fixed costs.
Illustration 4
Two businesses AB Ltd and CD Ltd sell the same type of product in the same market. Their
budgeted profits and loss accounts for the year ending 30th June, 2016 are as follows: Amount (`)
AB Ltd CD Ltd
Sales 1,50,000 1,50,000
Less: Variable costs 1,20,000 1,00,000
Fixed Cost 15,000 1,35,000 35,000 1,35,000
Profit 15,000 15,000
You are required to calculate the B.E.P of each business and state which business is likely to earn greater
profits in conditions.
(a) Heavy demand for the product
(b) Low demand for the product.

COST ACCOUNTING
Solution:
Statement Showing Computation of P/V ratio, BEP and Determination of Profitability in Different conditions:
Particulars AB Ltd CD Ltd
I. Sales 1,50,000 1,50,000
II. Variable cost 1,20,000 1,00,000
III. Contribution 30,000 50,000
IV. P/V ratio [(30,000/1,50,000) x 100] 20% 33 1/3%
[(50,000/1.50,000) x 100]
V. Fixed cost 15,000 35,000
VI. Profit 15,000 15,000
VII. Breakeven sales (V/IV) 75,000 1,05,000
From the above computation, it was found that the product produced by CD Ltd is more profitable in
conditions of heavy demand because its P/V ratio is higher. On the other hand, in the condition of
low demand, the product produced by AB Ltd is more profitable because its BEP is low.
Illustration 5
A factory is currently working to 40% capacity and produces 10,000 units. At 50% the selling price falls
by 3%. At 90% capacity the selling price falls by 5% accompanied by similar fall in prices of raw
material. Estimate the profit of the company at 50% and 90% capacity production.
The cost at present per unit is:
Material ` 10
Labour ` 3
Overheads ` 5(60% fixed)
The selling price per unit is ` 20/- per unit.
Solution:
Statement Showing Computation of Profit at 50% and 90% Capacity as well as at Current Capacity:
40% 50% 90%

Particulars Amount (`) Amount (`) Amount (`)
Unit Total Unit Total Unit Total
I. Selling price 20.00 2,00,000 19.40 2,42,500 19.00 4,27,500
II. Variable cost
Material 10.00 1,00,000 10.00 1,25,000 9.50 2,13,750
Labour 3.00 30,000 3.00 37,500 3.00 67,500
Variable OH 2.00 20,000 2.00 25,000 2.00 45,000
15.00 1,50,000 15.00 1,87,500 14.50 3,26,250
III. Contribution 5.00 50,000 4.40 55,000 4.50 1,01,250
IV. Fixed cost 3.00 30,000 30,000 30,000
V. Profit 20,000 25,000 71,250
VI. FS 1,20,000 1,32,273 1,26,667
B.E. sales
 C 
 

Illustration 6
The sales turnover and profit during two periods were as follows:
Amount (`)
Period Sales Profit
1 2,00,000 20,000
2 3,00,000 40,000
What would be probable trading results with sales of `1,80,000? What amount of sales will yield a profit
of ` 50,000?
Solution:
P/V ratio = (Change in profit / Change in sales) x 100
= (20,000 / 1,00,000) x 100 = 20%
Fixed cost = (Sales x P/V ratio) – Profit
= (2,00,000 x 0.2) – 20,000 = ` 20,000
Sales required to earn desired profit = Fixed cost + desired profit
P/V ratio
= (20,000 + 50,000) / 20% = ` 3,50,000
Illustration 7
The following results of a company for the last two years are as follows:
Amount (`)
Year Sales Profit
2014 1,50,000 20,000
2015 1,70,000 25,000
You are required to calculate:
(i) P/V Ratio
(ii) B.E.P
(iii) The sales required to earn a profit of ` 40,000
(iv) Profit when sales are ` 2,50,000
(v) Margin of safety at a profit of ` 50,000 and
(vi) Variable costs of the two periods.
Solution:
(i) P/V ratio = (Change in profit / Change in sales) x 100
= (5,000 / 20,000) x 100 = 25%
Fixed cost = (Sales x P/V ratio) – Profit = (1,50,000 x 25%) – 20,000 = ` 17,500
(ii) Break even sales = Fixed cost / PV ratio = 17,500 / 25% = ` 70,000
(iii) Sales required to earn a profit of ` 40,000 = Fixed cost + desired profit
P/V ratio
= (17,500 + 40,000) / 25% = ` 2,30,000

COST ACCOUNTING
(iv) Profit at sales ` 2,50,000 = (Sales x P/V ratio) – Fixed cost

= (2,50,000 x 25%) – 17,500 = ` 45,000
(v) Margin of safety at profit of ` 50,000 = Profit / PV ratio
= 50,000 / 25% = ` 2,00,000
(vi) Variable cost for 2011 = 1,50,000 x 75% = ` 1,12,500
Variable cost for 2012 = 1,70,000 x 75% = ` 1,27,500
Illustration 8
SV Ltd a multi product company furnishes you the following data relating to the year 2015:
Amount (`)
First Half of the year Second Half of the year
Sales 45,000 50,000
Total cost 40,000 43,000
Assuming that there is no change in prices and variable cost and that the fixed expenses are incurred
equally in the two half year period, calculate for the year, 2015
(i) The P/V Ratio, (iii) Break-even sales
(ii) Fixed Expenses (iv) Percentage of Margin of safety.
Solution:
(i) P/V ratio = [(7,000 – 5,000) / (50,000 – 45,000)] x 100 = 40%
(ii) Fixed expenses for first half year : = (Sales x PV ratio) – Profit
= (45,000 x 0.4) – 5,000 = ` 13,000
Fixed expenses for the year = 13,000 + 13,000 = ` 26,000
(iii) Break even sales = 26,000 / 40% = ` 65,000
(iv) Margin of safety = (50,000 + 45,000) – 65,000 = ` 30,000
Margin of safety ratio = [30,000 / (50,000 + 45,000)] x 100 = 31.58%
Illustration 9
S Ltd. furnishes you the following information relating to the half year ended 30th June, 2015.
Fixed expenses ` 45,000
Sales value `1,50,000
Profit ` 30,000
During the second half the year the company has projected a loss of `10,000.
Calculate:
(1) The B.E.P and M/S for six months ending 30th June, 2015.
(2) Expected sales volume for the second half of the year assuming that the P/V Ratio and Fixed
expenses remain constant in the second half year also.
(3) The B.E.P and M/S for the whole year for 2015.

Solution:
(1) P/V ratio = (Fixed cost + Profit) / Sales
P/V ratio : = [(45,000 + 30,000) / 1,50,000] x 100 = 50%
BE sales for I half year = 45,000 / 50% = ` 90,000
Margin of safety for I half year = 1,50,000 – 90,000 = ` 60,000
For II half year:
(2) P/V ratio = (Fixed cost + Profit) / Sales
0.5 = [45,000 + (-) 10,000] / Sales
0.5 sales = 35,000
 Sales = ` 70,000
(3) BE sales for 2015 = (45,000 + 45,000) x 50% = 1,80,000
Margin of safety for 2015 = (1,50,000 + 70,000) – 1,80,000 = ` 40,000
Illustration 10
The following is the statement of a Radical Co. for the month of June.
Amount (`)
Products Total
L M
Sales 60,000 60,000 1,20,000
Variable costs 42,000 30,000 72,000
Contribution 18,000 30,000 48,000
Fixed cost 36,000
Net Income 12,000
You are required to compute the P/V ratio for each product and then compute the P/V Ratio, Break-
even Point and net profit for the following assumption.
(i) Sales revenue divided 60% to Product L & 40% to Product M.
(ii) Sales revenue divided 40% to Product L & 60% to Product M.
Also calculate the profit estimated on sales upto ` 1,80,000/- p.m. for each of the sales mix provided
above.
Solution:
Computation of P/V ratio
Particulars L M Total
P/V ratio = (C/S) x 100 30% 50% 40%

COST ACCOUNTING
(i) For Assumption I:

Statement showing computation of P/V ratio, Break even point and profit Amount (`)
Sr. No. Particulars L M Total
I. Sales 72,000 48,000 1,20,000
II. Variable cost (L - 70%); (M – 50%) 50,400 24,000 74,400
III. Contribution (L – 30%); (M – 50%) 21,600 24,000 45,600
IV. Fixed cost 36,000
V. Profit 9,600
P/V ratio (45,600 x 1,20,000) / 100 = 38% 30% 50% 38%
Break even sales = 36,000 / 38% = ` 94,737
(ii) For Assumption II:

Statement showing computation of P/V ratio, Break even point and profit Amount (`)
Sr. No. Particulars L M Total
I. Sales 48,000 72,000 1,20,000
II. Variable cost (L - 70%); (M – 50%) 33,600 36,000 69,600
III. Contribution (L – 30%); (M – 50%) 14,400 36,000 50,400
V. Profit 14,400
P/V ratio (50,400 x 1,20,000) / 100 = 42% 30% 50% 42%
Break even sales = 36,000 / 42% = ` 85,714
Illustration 11
Accelerate Co. Ltd., manufactures and1sells four
2 types 2of products
1 under the brand names of A, B, C and
D. The sales Mix in value comprises 33 %, 41 %, 16 and 8 %,of products A, B, C & D respectively.
3 3 3 3
The total budgeted sales (100% are `60,000 p.m). Operating costs are:
Variable Costs:
Product A 60% of selling price
Product B 68% of selling price
Product C 80% of selling price
Product D 40% of selling price
Fixed Costs: ` 14,700 p.m.
(a) Calculate the break - even - point for the products on overall basis and
(b) Also calculate break-even-point, if the sales mix is changed as follows the total sales per month
remaining the same. Mix: A - 25% : B - 40% : C - 30% : D - 5%.
Solution:
Particulars A(`) B(`) C(`) D(`) Total(`)
I. Sales 20,000 25,000 10,000 5,000 60,000
II. Variable cost 12,000 17,000 8,000 2,000 39,000
III. Contribution 8,000 8,000 2,000 3,000 21,000
V. Profit 6,300
P/V ratio = (C/S) x 100 40% 32% 20% 60% 35%

(a) Break even sales

Break even sales = 14,700 / 35% = ` 42,000
(b) Amount (`)
I. Sales 15,000 24,000 18,000 3,000 60,000
II. Variable cost 9,000 16,320 14,400 1,200 40,920
III. Contribution 6,000 7,680 3,600 1,800 19,080
V. Profit 4,380
P/V ratio = (C/S) x 100 40% 32% 20% 60% 31.8 %
Break even sales = 14,700 / 31.8% = ` 46,226
Illustration 12
Present the following information to show to management:
(i) The marginal product cost and the contribution p.u.
(ii) The total contribution and profits resulting from each of the following sales mix results.
Amount (`)
Particulars Product Per unit
Direct Materials A 10
Direct Materials B 9
Direct wages A 3
Direct wages B 2
Fixed Expenses – ` 800
(Variable expenses are allotted to products at 100% Direct Wages)
Sales Price----------A ` 20
Sales Price----------B `15
Sales Mixtures: (a) 100 units of Product A and 200 of B.
(b) 150 units of Product A and 150 of B.
(c) 200 units of Product A and 100 of B.
Solution:
(i) Statement of Marginal Product cost Amount (`)
Sr. No. Particulars A B
I. Selling price 20.00 15.00
II. Variable cost
Direct material 10.00 9.00
Direct wages 3.00 2.00
Variable OHs (100% of direct wages) 3.00 2.00
16.00 13.00
III. Contribution (I – II) 4.00 2.00

COST ACCOUNTING
(ii) Profit at Mix (a): Amount (`)

Sr. No. Particulars A B Total
I. No. of units 100 200
II. ‘C’ per unit 4 2
III. Total contribution (II x I) 400 400 800
IV. Fixed cost 800
V. Profit (III - IV) Nil
Profit at Mix (b): Amount (`)
III. Total contribution (II x I) 600 300 900
IV. Fixed cost 800
V. Profit (III - IV) 100
Profit at Mix (c): Amount (`)
III. Total contribution (I x II) 800 200 1000
IV. Fixed cost 800
V. Profit (III - IV) 200
here ‘C’ means ‘Contribution’ .
Illustration 13
The following particulars are extracted from the records of a company:
PER UNIT
PRODUCT A PRODUCT B
Sales (`) 100 120
Consumption of material 2 Kg 3 Kg
Material cost (`) 10 15
Direct wages cost (`) 15 10
Direct expenses (`) 5 6
Machine hours used 3 Hrs 2 Hrs
Overhead expenses:
Fixed (`) 5 10
Variable (`) 15 20
Direct wages per hour is ` 5
(a) Comment on profitability of each product (both use the same raw material) when :
1) Total sales potential in units is limited;
2) Total sales potential in value is limited;
3) Raw material is in short supply;
4) Production capacity (in terms of machine hours) is the limiting factor.
(b) Assuming raw material as the key factor, availability of which is 10,000 Kgs. and each product
cannot be sold more than 3,500 units find out the product mix which will yield the maximum profit.

Solution:
(a) Statement showing computation of contribution per unit of different factors of production and
determination of profitability
Amount (`)
Sr.No. Particulars A B
I. Sales 100 120
II. Variable cost
Material 10 15
Labour 15 10
Direct expenses 5 6
Variable OH 15 20
45 51
III. Contribution (I - II) 55 69
IV. P/V ratio (III - I) 55% 57.5%
V. Contribution per kg of material 55/2 69/3
= 27.5 = 23
VI. Contribution per machine hour 55/3 69/2
= 18 1/3 = 34.5
From the above computations, we may comment upon the profitability in the following manner.
1. If total sales potential in units is limited, product B is more profitable, it has more contribution per
unit.
2. When total sales in value is limited, product B is more profitable because it has higher P/V ratio.
3. If the raw material is in short supply, Product A is more profitable because it has more contribution
per Kg of material.
4. If the production capacity is limited, product B is more profitable, because it has more contribution
per machine hour.
(b) Statement showing optimum mix under given conditions and computation of profit at that mix
Amount (`)
Sr.No. Particulars A B Total

I. No. of units 3,500 1,000
II. Contribution per unit 55 69
III. Total contribution 1,92,500 69,000 2,61,500
IV. Fixed cost (3500 x 5) (3500 x 10) 17,500 *35,000 52,500
V. Profit 2,09,000
* Fixed cost is taken at maximum capacity (3,500 x 10)
Working Notes: Kg.

Available material = 10,000
(-) utilized for A (3,500 x 2) =
7,000
= 3,000
Units of B = 3,000 / 3 = 1,000
COST ACCOUNTING
Illustration 14
A company has a capacity of producing 1 lakh units of a certain product in a month. The sales
department reports that the following schedule of sales prices is possible.
VOLUME OF PRODUCTION SELLING PRICE PER UNIT
% `
60 0.90
70 0.80
80 0.75
90 0.67
100 0.61
The variable cost of manufacture between these levels is 15 paise per unit and fixed cost ` 40,000.
Prepare a statement showing incremental revenue and differential cost at each stage. At which
volume of production will the profit be maximum?
Solution:
Statement showing computation of differential cost, incremental revenue and determination of
capacity at which profit is maximum: Amount (`)
Capacity Units Sales V. Cost Fixed cost Total Cost Differential Incremental
% @ (`) 0.15 Cost Revenue
60% 60,000 54,000 9,000 40,000 49,000 -- --
70% 70,000 56,000 10,500 40,000 50,500 1,500 2,000
80% 80,000 60,000 12,000 40,000 52,000 1,500 4,000
90% 90,000 60,300 13,500 40,000 53,500 1,500 300
100% 1,00,000 61,000 15,000 40,000 55,000 1,500 700
From the above computation, it was found that the incremental revenue is more than the differential
cost up to 80% capacity, the profit is maximum at that capacity.
Illustration 15
A company is at present working at 90 per cent of its capacity and producing 13,500 units per annum.
It operates a flexible budgetary control system. The following figures are obtained from its budget.
90% 100%
Sales 15,00,000 16,00,000
Fixed expenses 3,00,500 3,00,600
Semi-fixed expenses 97,500 1,00,500
Variable expenses 1,45,000 1,49,500
Units made 13,500 15,000
Labour and material costs per unit are constant under present conditions. Profit margin is 10 per cent.
(a) You are required to determine the differential cost of producing 1,500 units by increasing capacity
to 100%
(b) What would you recommend for an export price for these 1,500 units taking into account that
overseas prices are much lower than indigenous prices?

Solution:
Computation of material and labour cost

Sales at present 15,00,000
(-) Profit @ 10% 1,50,000
Total cost 13,50,000
(-) All costs other than material & labour
Fixed expenses 3,00,500 5,43,000
Semi fixed expenses 97,500
Variable expenses 1,45,000
Material & Labour cost 8,07,000
(a) Statement showing differential cost of 1500 units

Material & Labour (8,07,000 x 1500/13500) 89,667
Fixed expenses (3,00,600 – 3,00,500) 100
Semi fixed expenses (1,00,500 – 97,500) 3,000
Variable expenses (1,49,500 – 1,45,000) 4,500
Differential cost 97,267
(b) Differential cost per unit = 97,267 / 1,500 = ` 64.84
The minimum price for these 1,500 units should not be less than ` 64.84
Illustration 16
The operating statement of a company is as follows: Amount (`)
Sales (80,000 @ `15 each) 12,00,000
Costs:
Variable: (`)
Material 2,40,000
Labour 3,20,000
Overheads 1,60,000
7,20,000
Fixed Cost 3,20,000 10,40,000
PROFIT 1,60,000
The capacity of the plant is 1 lakh units. A customer from U.S.A. is desirous of buying 20,000 units at a
net price of `10 per unit. Advice the producer whether or not offer should be accepted. Will your
advice be different, if the customer is local one.

COST ACCOUNTING
Solution:
Statement showing computation of profit before and after accepting the order
Amount (`)
Sr. Particulars Present Position Order Value Total

No. (Before accepting) (20,000) (After
80,000 accepting)
1,00,000
I. Sales 12,00,000 2,00,000 14,00,000
II. Variable Cost
Material 2,40,000 60,000 3,00,000
Labour 3,20,000 80,000 4,00,000
Variable OH 1,60,000 40,000 2,00,000
7,20,000 1,80,000 9,00,000
III. Contribution (I - II) 4,80,000 20,000 5,00,000
IV. Fixed cost 3,20,000 -- 3,20,000
V. Profit (III - IV) 1,60,000 20,000 1,80,000
As the profit is increased by ` 20,000 by accepting the order, it is advised to accept the same. If
the order is from local one, it should not be accepted because it will adversely affect the present
market.
Illustration 17
A company manufactures scooters and sells it at `3,000 each. An increase of 17% in cost of
materials and of 20% of labour cost is anticipated. The increased cost in relation to the present sales
price would cause at 25% decrease in the amount of the present gross profit per unit.
At present, material cost is 50%, wages 20% and overhead is 30% of cost of sales.
You are required to :
(a) Prepare a statement of profit and loss per unit at present and;
(b) Compute the new selling price to produce the same percentage of profit to cost of sales as
before.
Solution:
Let X and Y be the cost and profit respectively.
X + Y = 3,000  (1)
Material = X x 50/100 = 0.5X
Labour = X x 20/100 = 0.2X
Overheads = X x 30/100 = 0.3X
After increase of cost:
Material = 0.5 X x 117/100 = 0.585 X
Labour = 0.2X x 120/100 = 0.240 X
Overheads = 0.300 X

= 1.125 X

COST ACCOUNTING
Profit = Y x 75/100 = 0.75Y

 New Equation 1.125X + 0.75Y = 3,000 → (2)
Multiplying Eq. (1) by 0.75 0.75X + 0.75Y = 2,250
0.375X = 750
X = 750/0.375 = ` 2,000
Y = 3,000 – 2,000 = ` 1,000
Statement of cost & profit per unit at present

Amount (`)
Material = 2,000 x 50% = 1,000
Labour = 2,000 x 20% = 400
Overheads = 2,000 x 30% = 600
= 2,000
(+) profit @ 50% of cost = 1,000
= 3,000
Computation of new selling price to get same percentage of profit

Amount (`)
Material = 1,000 x 117/100 = 1,170
Labour = 400 x 120/100 = 480
Overheads = 600
Cost = 2,250
(+) Profit @ 50% = 1,125
New selling price = 3,375
Illustration 18
An umbrella manufacturer marks an average net profit of ` 2.50 per piece on a selling price of `14.30
by producing and selling 6,000 pieces or 60% of the capacity. His cost of sales is
Amount (`)
Direct material 3.50
Direct wages 1.25
Works overheads (50% fixed) 6.25
Sales overheads (25% variable) 0.80
During the current year, he intends to produce the same number but anticipates that fixed charges
will go up by 10% which direct labour rate and material will increase by 8% and 6% respectively but
he has no option of increasing the selling price. Under this situation, he obtains an offer for further
20% of the capacity. What minimum price you will recommend for acceptance to ensure the
manufacturer an overall profit of `16,730.

COST ACCOUNTING
Solution:
Computation of profit at present after increase in cost

I. Selling price 14.30
II. Variable cost
Material (3.5 x 3.710
106/100) Labour (1.25 x 1.350
108/100) Works 3.125
overhead 0.200
Sales overhead
Total 8.385
III. Contribution per unit (I-II) 5.915
IV. Total contribution (6,000 x 5.915) 35,490
V. Fixed cost
Works OH 3.125 24,585
Sales OH 0.600 [3.725 x 6,000 = 22,350 x 110/100]
VI. Profit (iv - v) 10,905
Computation of selling price of the order: (`)
Variable cost of order (2,000 x 8.385) = 16,770
(+) required profit (16,730 – 10,905) = 5,825
Sales required = 22,595
Selling price of order = 22,595/2,000 = 11.2975 (or) ` 11.30
Illustration 19
The Dynamic company has three divisions. Each of which makes a different product. The
budgeted data for the coming year are as follows:
Amount (`)
A B C
Sales 1,12,000 56,000 84,000
Direct Material 14,000 7,000 14,000
Direct Labour 5,600 7,000 22,400
Direct Expenses 14,000 7,000 28,000
Fixed Cost 28,000 14,000 28,000
61,600 35,000 92,400
The Management is considering to close down the division C’. There is no possibility of reducing
fixed cost. Advise whether or not division C’ should be closed down.

Solution:
Statement showing computation of profit before closing down of division C
Amount (`)
Sr. No. Particulars A B C Total

I. Sales 1,12,000 56,000 84,000 2,52,000
II. Variable cost
Direct Material 14,000 7,000 14,000 35,000
Direct Labour 5,600 7,000 22,400 35,000
Direct expenses 14,000 7,000 28,000 49,000
III. Total Variable Cost 33,600 21,000 64,400 1,19,000
IV. Contribution (i - iii) 78,400 35,000 19,600 1,33,000
V. Fixed cost 70,000
Statement showing computation of profit after closing C

Amount (`)

I. Sales 1,12,000 56,000 1,68,000
II. Variable cost
Direct Material 14,000 7,000 21,000
Direct Labour 5,600 7,000 12,600
Direct expenses 14,000 7,000 21,000
III. Total Variable Cost 33,600 21,000 54,600
IV. Contribution (i - iii) 78,400 35,000 1,13,400
V. Fixed cost 70,000
From the above computations, it was found that profit is decreased by (`63,000 - `43,400) ` 19,600
by closing down division ‘C’, it should not be closed down. In other words, as long as if there is a
contribution of ` 1, from division ‘C’, it should not be closed down.
Illustration 20
Mr. Young has ` 1,50,000 investment in a business. He wants a 15% profit on his money. From an
analysis of recent cost figures he finds that his variable cost of operating is 60% of sales; his fixed costs
are `75,000 per year. Show supporting computations for each answer.
(a) What sales volume must be obtained to break-even?
(b) What sales volume must be obtained to his 15% return on investment?
(c) Mr. Young estimates that even if he closed the doors of his business he would incur `25,000 expenses
per year. At what sales would be better off by locking his sales up?

COST ACCOUNTING
Solution:
P/V ratio (V. cost ratio 60%) = 40%

(a) Break even sales = 75,000 / 40% = ` 1,87,500
(b) Required sales to get desired income = (75,000 + 22,500) / 40% = ` 2,43,750 = ` 2,43,750
(c) Shut down sales Fixed cost – shut down cost

=
P/V Ratio
= (75,000 – 25,000) / 40% = ` 1,25,000
Illustration 21
The manager of a Co. provides you with the following information:
Amount (`)
Sales : 4,00,000
Costs: Variable
(60% of sales)
Fixed cost : 80,000
Profit before tax : 80,000
Income-tax (60%)
Net profit : 32,000
The company is thinking of expanding the plant. The increased fixed cost with plant expansion will be
`40,000. It is estimated that the maximum production in new plant will be worth `2,40,000. The
company also wants to earn additional income `3,200 on investment. On the basis of computations
give your opinion on plant expansion.
Solution:
Statement showing computation of profit before and after plant expansion
Amount (`)
Sr. Particulars Present Expansion Total

No. (Before expansion) value (After expansion)
I. Sales 4,00,000 2,40,000 6,40,000
II. Variable cost (60%) 2,40,000 1,44,000 3,84,000
III. Contribution (i - ii) 1,60,000 96,000 2,56,000
IV. Fixed cost 80,000 40,000 1,20,000
V. Profit before tax (iii - iv) 80,000 56,000 1,36,000
VI. Profit after tax (V x 0.40) 32,000 22,400 54,400
From the above computations, it was found that the profit is increased by ` 22,400 by expanding
the plant, which is much higher than the expected income of ` 3,200, one’s opinion should be in
favour of plant expansion.

6.2 STANDARD COSTING & VARIANCE ANLYSIS
Standard Cost
Standard Cost is defined as “the predetermined cost that is calculated at the management’s standards
of efficient operations and the relevant necessary expenditure”.
From this we understand that it is the cost calculated when all the people working in the
organisation to their utmost, the expenditure incurred for producing the product can be taken as
standard cost. The optimum efficiency can not at all time exists. Therefore, optimum efficiency is
assumed and that is why standard cost is called assumed cost. Further, all the inputs of cost
scientifically analysed using so many industrial engineering techniques such as work measurement,
method study, time and motion study, merit rating, job evaluation and other scientific techniques, it
can also be called as Scientific Cost.
Standard Costs and Estimated Costs

The distinction between Standard Costs and Estimated Costs should be clearly understood. While
both Standard Costs and Estimated Costs are predetermined costs, their objectives are different.
The main differences between the two types of costs are:
1. Estimated Costs are intended to determine what the costs ‘will’ be. Standard Costs aim at what
costs ‘should’ be.
2. Estimated Costs are based on average of past actual figures adjusted for anticipated changes
in future. Anticipated wastes, spoilage and inefficiencies, all of which tend to increase costs are
included in estimated costs. Standard Costs are planned costs determined on a scientific basis
and they are based upon certain assumed conditions of efficiency and other factors.
3. In Estimated Costing Systems, stress is not so much on cost control, but costs are used for
other purposes such as fixation of prices to be quoted in advance. Standard Costs serve as
effective tools for cost control.
Types of Standards
There are different types of standards stated as follows:
(i) Ideal Standard: Ideal standard represents the level of performance attainable when prices for
material and labour are most favourable, when the highest output is achieved with the best
equipments and layout and when the maximum efficiency in utilising the resources results in
maximum output with minimum cost. However, this type of standard is criticised due to the fact
that such standard is practically unattainable.
(ii) Normal Standard: Normal standard can be achieved under normal operating conditions. The
normal activity is the number of standard hours which will produce at normal efficiency
sufficiently good enough to meet the average sales demand over a period of time. This
standard requires a degree of forecasting. Under this system the variances are deviations from
normal efficiency, normal sales volume, or normal production volume.
(iii) Basic Standard: Basic standard is applied only when it is likely to remain constant over a long
period of time. A base year is chosen for the purpose of comparison. Since basic standard does
not represent what should be attained in the present period, current standard should also be
prepared when basic standard is used.
(iv) Current Standard: Current standard reflects the management’s anticipation of what actual
costs will be for the current period. These are the costs that the firm will incur if anticipated
prices are paid for the goods and services and the usage necessary to produce the planned
COST ACCOUNTING
output.

Stock Valuation
The function of a Balance Sheet is to give a true and fair view of the state of affairs of a company on
a particular date. A true and fair view also implies the consistent application of generally accepted
principles. Stocks valued at standard costs are required to be adjusted at actual costs in the
following circumstances:
(a) As per Accounting Standards – 2, closing stock to be valued either at cost price or at net realisable
value (NRV) whichever is less.
(b) The standard costing system introduced is still in an experimental stage and the variances
merely represent deviations from poorly set standards.
(c) Occurrence of certain variances which are beyond the control of the management. (Unless
the stocks are adjusted for uncontrollable factors, the values are not correctly started).

COST ACCOUNTING
Difference between Standard Costing and Budgetary Control

The difference may be summarized as follows:
1. A system of Budgetary Control may be operated even if no Standard Costing system is in use in
the concern.
2. While standard is an unit concept, budget is a total concept.
3. Budgets are the ceilings or limits of expenses above which the actual expenditure should not
normally rise; if it does, the planned profits will be reduced. Standards are minimum targets to
be attained by actual performance at specified efficiency.
4. Budgets are complete in as much as they are framed for all the activities and functions of a
concern such as production, purchase, selling and distribution, research and development,
capital utilisation, etc. Standard Costing relates mainly to the function of production and the
related manufacturing costs.
5. A more searching analysis of the variances from standards is necessary than in the case of
variations from the budget.
6. Budgets are indices, adherence to which keeps a business out of difficulties. Standards are pointers
to further possible improvements.
Advantages of Standard Costing

The advantages derived from a system of standard costing are tabulated below:
1. Standard Costing system establishes yard-sticks against which the efficiency of actual performances
is measured.
2. The standards provide incentive and motivation to work with greater effort and vigilance for
achieving the standard. This increase efficiency and productivity all round.
3. At the very stage of setting the standards, simplification and standardisation of products,
methods, and operations are effected and waste of time and materials is eliminated. This
assists in managerial planning for efficient operation and benefits all the divisions of the
concern.
4. Costing procedure is simplified. There is a reduction in paper work in accounting and less number
of forms and records are required.

5. Cost are available with promptitude for various purposes like fixation of selling prices, pricing of
inter- departmental transfers, ascertaining the value of costing stocks of work-in-progress and
finished stock and determining idle capacity.
6. Standard Costing is an exercise in planning - it can be very easily fitted into and used for budgetary
planning.
7. Standard Costing system facilities delegation of authority and fixation of responsibility for each
department or individual. This also tones up the general organisation of the concern.
8. Variance analysis and reporting is based on the principles of management by exception. The top
management may not be interested in details of actual performance but only in the variances
form the standards, so that corrective measures may be taken in time.
9. When constantly reviewed, the standards provide means for achieving cost reduction.
10. Standard costs assist in performance analysis by providing ready means for preparation of
information.
11. Production and pricing policies may be formulated in advance before production starts. This
helps in prompt decision-making.
12. Standard costing facilitates the integration of accounts so that reconciliation between cost accounts
and financial accounts may be eliminated.
13. Standard Costing optimizes the use of plant capacities, current assets and working capital.
Limitations of standard costing

1. Establishment of standard costs is difficult in practice.
2. In course of time, sometimes even in a short period the standards become rigid.
3. Inaccurate, unreliable and out of date standards do more harm than benefit.
4. Sometimes, standards create adverse psychological effects. If the standard is set at high level, its
non achievement would result in frustration and build-up of resistance.
5. Due to the play of random factors, variances cannot sometimes be properly explained, and it is
difficult to distinguish between controllable and non-controllable expenses.
6. Standard costing may not sometimes be suitable for some small concerns. Where production
cannot be carefully scheduled, frequent changes in production conditions result in variances.
Detailed analysis of all of which would be meaningless, superfluous and costly.
7. Standard costing may not, sometimes, be suitable and costly in the case of industries dealing
with non-standardized products and for repair jobs which keep on changing in accordance with
customer’s specifications.
8. Lack of interest in standard costing on the part of the management makes the system
practically ineffective. This limitation, of course, applies equally in the case of any other system
which the management does not accept wholeheartedly.
Process of Standard Costing

There are different processes of standard costing as enumerated below:
(i) Setting of standards
(ii) Determination of actual costs

COST ACCOUNTING
(iii) Comparison of standard cost with the actual costs

(iv) Finding out the reasons for variances
(v) Taking corrective action and disposal of variances
Types of Variances
Following are the types of variances:
(i) Controllable and Uncontrollable variance
(ii) Favourable and Adverse Variance
Controllable variances are those which can be controlled by the departmental heads whereas
Uncontrollable variances are those which are beyond their control. However, controllability is a
subjective matter and varies according to situations. If the Uncontrollable variances are of significant
nature and persistent, the standard may need revision.
Favourable variances are those which are profitable for the company and Adverse variances
are those which cause loss to the company. While computing cost variances favourable variances
means actual cost is less than standard cost. On the contrary, adverse variances means actual cost
exceeding standard cost. However, the situation will be reverse for Sales variance .Favourable
variance means actual sales are more than budgeted. On the contrary Adverse variance means actual
sales are less than budgeted. In short favourable variance is written as ‘F’ and adverse variance as
‘A’.
Classification of variances (Material and Labour only)
Material Cost Variance
Usage Price
Variance Variance
Sub-usage Mix Yield
Labour Cost Variance
Efficiency Rate
Variance Variance
Sub-efficiency
Mix Yield
(or)
Gang (or)
Composition
Idle Time Variance

Direct Materials Cost Variance: Direct materials cost variance is the difference between the actual direct
material cost incurred and the standard direct material cost specified for the production achieved.
1. Direct Materials Price Variance: The difference between the actual and standard price per unit
of the material applied to the actual quantity of material purchased or used.
Direct materials price variance = (Standard Price minus Actual Price) x Actual Quantity, or
= (SP-AP) AQ
= (Standard Price x Actual Quantity) minus (Actual Price x Actual Quantity)
= (AQSP-AQAP)
Causes of Material Price Variance

a. Change in basic purchase price of material
b. Change in quantity of purchase or uneconomical size of purchase order
c. Rush order to meet shortage of supply, or purchase in less or more favourable market
d. Failure to take advantage of off-season price, or failure to purchase when price is cheaper
e. Failure to obtain (or availability of) cash and trade discounts or change in the discount rates
f. Weak purchase organisation
g. Payment of excess or less freight
h. Transit losses and discrepancies, if purchase price is inflated to include the loss
i. Change in quality or specification of material purchased
j. Use of substitute material having a higher or lower unit price
k. Change in materials purchase, upkeep, and store-keeping cost. (This is applicable only when
such changes are allocated to direct material costs on a predetermined or standard cost basis.)
l. Change in the pattern or amounts of taxes and duties
2. Direct Materials Usage Variance: The difference between the actual quantity used and the
amount which should have been used, valued at standard price.
Direct materials usage variance = (Standard Quantity for actual output x Standard Price) minus
(Standard Price x Actual Quantity)
= SQSP-AQSP or
= Standard Price x (Standard Quantity for actual output minus Actual Quantity)
= SP (SQ-AQ)
Causes of Materials Usage Variance

a. Variation in usage of materials due to inefficient or careless use, or economic use of materials.
b. Change in specification or design of product
c. Inefficient and inadequate inspection of raw materials
d. Purchase of inferior materials or change in quality of materials
e. Rigid technical specifications and strict inspection leading to more rejections which require more
materials for rectification
f. Inefficiency in production resulting in wastages
g. Use of substitute materials

COST ACCOUNTING
h. Theft or pilferage of materials

i. Inefficient labour force leading to excessive utilisation of materials
j. Defective machines, tools, and equipments, and bad or improper maintenance leading to
breakdowns and more usage of materials
k. Yield from materials in excess of or less than that provided as the standard yield
l. Faulty materials processing. Timber, for example, if not properly seasoned may be wasted while
being used in subsequent processes
m. Accounting errors, e.g. when materials returned from shop or transferred from one job to
another are not properly accounted for
n. Inaccurate standards
o. Change in composition of a mixture of materials for a specified output
(i) Direct Materials Mix Variance: One of the reasons for materials usage variance is the change in
the composition of the materials mix. The difference between the actual quantity of material
used and the standard proportion, priced at standard price.
Mix variance = (Revised Standard Quantity minus Actual Quantity) x Standard Price.
= RSQSP-AQSP
(ii) Direct Materials Yield Variance: Yield variance is the difference between the standard cost
of production achieved and the actual total quantity of materials used, multiplied by the
standard weighted average price per unit.
Material yield variance = (Standard Yield for Actual Mix minus Actual Yield) x Standard Yield Price
(Standard yield price is obtained by dividing the total cost of the standard units by the total cost
of the standard mixture by the total quantity (number of physical units).
(1) (2) (3) (4)

SQSP RSQSP AQSP AQAP
(1-2) (2-3)
(1-3) (3-4)
(1-4)
Where
SQ = Standard Quantity for Actual Production or Output
SP = Standard Price
AQ = Actual Quantity of Materials Consumed
AP = Actual Price
RSQ = Revised Standard Quantity
1. SQSP = Standard Cost of Standard Material
2. RSQSP = Revised Standard Cost of Standard Material
3. AQSP = Standard cost of Actual Material

4. AQAP = Actual Cost of Actual Material

(a) Material Sub-Usage or Yield Variance = 1-2
(b) Material Mix Variance = 2-3
(c) Material Usage Variance = 1-3
(d) Material Price Variance = 3-4
(e) Material Cost Variance = 1-4
II. Direct Labour Cost Variance: Direct Labour Cost Variance (also termed Direct Wage Variance) is
the difference between the actual direct wages incurred and the standard direct wages specified
for the activity achieved.
1. Direct Labour Rate Variance (Wage Rate Variance): The difference between the actual and
standard wage rate per hour applied to the total hours worked.
Wages rate variance = (Standard Rate minus Actual Rate) x Actual Hours
= (SR-AR) x AH
= SRAH-ARAH
Causes of Direct Labour Rate Variances
a. Change in basic wage structure or change in piece-work rate. These will give rise to a
variance till such time the standards are not revised
b. Employment of workers of grades and rates of pay different from those specified, due to
shortage of labour of the proper category, or through mistake, or due to retention of
surplus labour
c. Payment of guaranteed wages to workers who are unable to earn their normal wages if
such guaranteed wages form part of direct labour cost
d. Use of a different method of payment, e.g. payment at day-rates while standards are
based on piece-work method of remuneration.
e. Higher or lower rates paid to casual and temporary workers employed to meet seasonal
demands, or urgent or special work
f. New workers not being allowed full normal wage rates
g. Overtime and night shift work in excess of or less than the standard, or where no provision
has been made in the standard. This will be applicable only if overtime and shift differential
payments form part of the direct labour cost.
h. The composition of a gang as regards the skill and rates of wages being different from that
laid down in the standard
2. Direct Labour Efficiency Variance (also termed Labour Time Variance): The difference between
the standard hours which should have been worked and the hours actually worked, valued at the
standard wage rate.
Direct Labour Efficiency Variance = (Standard Hours for Actual Production minus Actual Hours)
x Standard Rate
= (SH-AH) x SR
= SRSH-SRAH
Causes for Labour Efficiency Variance
a. Lack of proper supervision or strict supervision than specified
b. Poor working conditions

COST ACCOUNTING
c. Delays due to waiting for materials, tools, instructions, etc. if not treated as idle time
d. Defective machines, tools and other equipments
e. Machine break-down, if not booked to idle time
f. Work on new machines requiring less time than provided for, till such time standard is not revised
g. Basic inefficiency of workers due to low morale, insufficient training, faulty instructions, incorrect
scheduling of jobs, etc.
h. Use of non-standard material requiring more or less operation time
i. Carrying out operations not provided for a booking them as direct wages
j. Incorrect standards
k. Wrong selection of workers, i.e., not employing the right type of man for doing a job
l. Increase in labour turnover
m. Incorrect recording of performances, i.e., time or output
i. Direct Labour Composition or Mix or Gang Variance: This is a sub-variance of labour efficiency
variance. This variance arises due to change in the composition of a standard gang, or, combination
of labour force.
Mix or Gang or Composition Variance = (Actual Hours at Standard Rate of Standard Gang) minus
(Actual Hours at Standard Rate of Actual Gang)
ii. Direct Labour Yield Variance: Just as material yield variance is calculated, similarly labour
yield variance can also be known. It is the variation in labour cost on account of increase or
decrease in yield or output as compared to the relative standard. The formula is –
Standard Output Actual

Direct Labour Yield Variance = Standard Cost Per Unit ×
for Actual Mix
– Output
3. Idle time variance: This variance which forms a portion of wages efficiency variance, is
represented by the standard cost of the actual hours for which the workers remain idle due to
abnormal circumstances.
Idle time variance = (Standard rate x Actual hours paid for) minus (Standard rate x Actual hours
worked) or
= Standard Rate x Idle Hours
(1) (2) (3) (4)
SRSH SRRSH SRAH ARAH
(1-2) (2-3)
(1-3) (3-4)
(1-4)
SR = Standard Rate of Labour Per Hour

SH = Standard Hours for Actual Production or Output
RSH = Revised Standard Hours

AH = Actual Hours
AR = Actual Rate of Labour per Hour
1. SRSH = Standard Cost of Standard Labour
2. SRRSH = Revised Standard Cost of Labour
3. SRAH = Standard Cost of Actual Labour
4. ARAH = Actual Cost of Labour
a. Labour Sub-Efficiency or Yield Variance = 1-2
b. Labour Mix or Gang or Composition Variance = 2-3
c. Labour Efficiency Variance = 1-3
d. Labour Rate Variance = 3-4
e. Labour Cost Variance = 1-4
Idle Time Variance = Idle Time Hours x Standard Rate per Hour.
It is to be noted that this is the part and parcel of efficiency ratio and always it is adverse.
Illustration 1
Product A required 10 kg of material at a rate of `4 per kg. The actual consumption of material for
the manufacturing product A comes to 12 kg of material at the rate of `4.50 per kg.
Calculate: (a) Material Cost Variance
(b) Material Usage Variance
(c) Material Price Variance.
Solution:
Computation of Required Values
Let (1) SQSP = Standard Cost of Standard Material
(2)AQSP = Standard Cost of Actual Material
(3)AQAP = Actual Cost of Material
Given Values:
SQ = Standard Quantity of Material = 10 kg
AQ = Actual Quantity of Material = 12 kg
SP = Standard Price = ` 4 per kg
AP = Actual Price = ` 4.50 per kg.
(1) SQSP = (10 x 4) = ` 40
(2) AQSP = (12 x 4) = ` 48
(3) AQAP = (12 x 4.50) = ` 54

COST ACCOUNTING
Computation of Required Material Variances
a. Material Usage Variance = (1) – (2) = 40-48 = `8 (A)
b. Material Price Variance = (2) – (3) = 48-54 = `6 (A)
c. Material Cost Variance = (1) – (3) = 40-54 = `14 (A)
Illustration 2
The standard quantity and standard price of raw material required for one unit of product A are
given as follows
Quantity (kg.) S.P. (`)
Material X 2 3
Material Y 4 2
The actual production and relevant data are as follows:
Material X 1,100 kgs. @ ` 3,410
Material Y 1,800 kgs. @ ` 3,960
Calculate Variances. Actual production was 500 units.
Solution:
Analysis of Given Data

Amount (`)
Standard Data Actual Data

Material Quantity (Kg.) Price Value Quantity (Kg.) Price Value
A 1000 (500 x 2) 3.00 3,000 1,100 3.10 3,410
B 2000 (500 x 4) 2.00 4,000 1,800 2.20 3,960
3000 7,000 2,900 7,370
Amount (`)
Material SQSP RSQSP AQSP AQAP

X 966.67 x 3 = 2,900 1,100 x 3
Y 1933.33 x 2 = 3,867 1,800 x 2

Total 7,000 6,767 6,900 7,370
Where (1) SQSP = Standard Cost of Standard Material = ` 7,000
(2)RSQSP = Revised Standard Cost of Material = ` 6,767
(3)AQSP = Standard Cost of Actual Material = ` 6,900
(4)AQAP = Actual Cost of Material = ` 7,370

Computation of Variances
(a) Material Sub-usage variance = (1) – (2) = 7,000 – 6,767 = ` 233 (F)
(b) Material Mix variance = (2) – (3) = 6,767 – 6,900 = ` 133 (A)
(c) Material Usage variance = (1) – (3) = 7,000 – 6,900 = `100 (F)
(d) Material price variance = (3) – (4) = 6,900 – 7,370 = ` 470 (A)
(e) Material cost variance = (1) – (4) = 7,000 – 7,370 = ` 370 (A)
Illustration 3
From the following you are required to calculate
(a) Material Usage Variance
(b) Material Price Variance
(c) Material Cost Variance
Quantity of material purchased 3,000 units
Value of material purchased ` 9,000
Standard quantity of material required
for one tonne of finished product 25 units
Standard rate of material ` 2 per unit
Opening stock of material NIL
Closing stock of material 500 units
Finished production during the period 80 tonnes
Solution:
Given Values:
SQ = Standard Quantity for Actual Production = 25 x 80 = 2,000 units.
AQ = Actual Quantity = 2,500 units (3,000 units – 500 units)
SP = Standard Price = `
2 AP = Actual Price = ` 3
(1)SQSP = Standard Cost of Standard Material = 2,000 x 2 = `4,000
(2)AQSP = Standard Cost of Actual Material = 2,500 x 2 = ` 5,000
(3)AQAP = Actual Cost of Material = ` 7,500 (2,500 units × ` 3 per unit)
Computation Of Material Variances:
a. Material usage variance = (1) – (2) = ` (4,000 – 5,000) = ` 1,000 (A)
b. Material price variance = (2) – (3) = ` (5,000 – 7,500) = ` 2,500 (A)
c. Material cost variance = (1) – (3)= ` (4,000 – 7,500) = ` 3,500 (A)

COST ACCOUNTING
Illustration 4
From the following information, compute (a) Mix, Price and Usage Variances.
Quantity (Kg.) Unit Rate (`) Total (`)

Standard:
Material A 10 2 20
Material B 20 3 60
Material C 20 6 120
50 200
Actual:
5 3 15
Material A 10 6 60
Material B
15 5 75
Material C
30 150
Solution:
Amount (`)
Materials (1) SQSP (2) RSQSP (3) AQSP (4) AQAP

A 10 x 2 = 20 6 x 2 = 12 5 x 2 = 10 5 x 3 = 15
B 20 x 3 = 60 12 x 3 = 36 10 x 3 = 30 10 x 6 = 60
C 20 x 6 = 120 12 x 6 = 72 15 x 6 = 90 15 x 5 = 75
200 120 130 150
RSQ For A = 10/50 × 30 = 6 units
RSQ For B = 20/50 x 30 = 12
units RSQ For C = 20/50 x 30
=12 units
Where (1) SQSP = Standard Cost of Standard Material = ` 200
(2) RSQSP = Revised Standard Cost of Material = ` 120
(3) AQSP = Standard Cost of Actual Material = ` 130

(4) AQAP = Actual Cost of Material = ` 150
Computation of Required Variances

(a) Material Sub-Usage Variance = (1) – (2) = ` 200 – ` 120 = `80 (F)
(b) Material Mix Variance = (2) – (3) = ` 120 – ` 130 = `10 (A)
(c) Material Usage Variance = (1) – (3) = ` 200 – `130 = `70 (F)
(d) Material Price Variance = (3) – (4) = `130 – `150 = `20 (A)
(e) Material Cost Variance = (1) – (4) = ` 200 – ` 150 = `50 (F)
Illustration 5
From the data given below, calculate the Material Price Variance, Material Usage Variance and
Material Mix Variance:
Raw Material Standard Actual

A 40 units @ `50 per unit 50 units @ `50 per unit
B 60 units @ `40 per unit 60 units @ `45 per unit
Solution: Amount (`)
Material Q P Value Q P Value

A 40 50 2,000 50 50 2,500
B 60 40 2,400 60 45 2,700
100 4,400 110 5,200
Computation of Required Values Amount (`)
Material (1)SQSP (2) RSQSP (3) AQSP (4) AQAP

A 40 x 50 = 2,000 44 x 50 = 2,200 50 x 50 = 2,500 50 x 50 = 2,500
B 60 x 40 = 2,400 66 x 40 = 2,640 60 x 40 = 2,400 60 x 45 = 2,700
4,400 4,840 4,900 5,200
RSQ For A = 40/100 x 110 = 44 units
RSQ For B = 60/100 ×110 = 66 units
Where (1) SQSP = Standard Cost of Standard Material = ` 4,400
(2)RSQSP = Revised Standard Cost of Material = ` 4,840
(3)AQSP = standard Cost of Actual Material = ` 4,900
(4)AQAP = Actual Cost of Material = ` 5,200
Computation of Required Variances:

(a) Material Sub-Usage Variance = (1) – (2) = ` 440 (A) [` 4,400 – ` 4,840]
(b) Material Mix Variance = (2) – (3) = ` 60 (A) [` 4,840 – ` 49,00]
(c) Material Usage Variance = (1) – (3) = ` 500 (A) [` 4,400 – ` 4,900]
(d) Material Price Variance = (3) – (4) = ` 300 (A) [` 4,900 – ` 5,200]
(e) Material Cost Variance = (1) – (4) = ` 800 (A) [` 4,400 – ` 5,200]
Illustration 6
The standard material cost for 100 kg of chemical D is made up :
Chemical A 30 kg. @ ` 4 per
kg Chemical B 40 kg. @ ` 5
per kg Chemical C 80 kg. @ `
6 per kg
COST ACCOUNTING
In a batch 500 kg. of chemical D were produced from a mix of

Chemical A 140 kg. @ ` 588
Chemical B 220 kg. @ ` 1,056
Chemical C 440 kg. @ ` 2,860
How do you yield mix and price of factors contribute to the variance in the actual cost per 100 kg. of
chemical D over the standard cost ?
Solution:
Analysis of Given Data
Amount (`)
Chemical Standard Data Actual Data
Quantity Price Value Quantity Price Value
A 30 4 120 28 117.60
B 40 5 200 44 211.20
C 80 6 480 88 572.00
150 800 160 900.80
Less: Loss 50 - 60 -
100 800 100 900.80

Amount (`)
Chemical (1) SQSP (`) (2) RSQSP (`) (3) AQSP (`) (4) AQAP (`)
A 30 × 4 =120 32.00 x 4 = 128.00 28 x 4 = 112.00 117.60
B 40 × 5 = 200 42.67 x 5 = 213.35 44 x 5 = 220.00 211.20
C 80 × 6 = 480 85.33 x 6 = 512.00 88 x 6 = 528.00 572.20
800.00 853.35 860.00 900.80
Computation of RSQ:
 SQ for that product 
RSQ =  SQ for all product  x AQ for that product
 
 30 
For A =  x 160 = 32.00 units.
 150 
 40 
For B = x 160 = 42.67 units.
 150
 
 80 
For C = x 160 = 85.33 units.
 150
 
Where (1) SQSP = Standard cost for Standard material = ` 800

(2) RSQSP = Revised standard cost of material = ` 853.35
(3) AQSP = Standard cost of actual material = ` 860.00
(4) AQAP = Actual cost of material = ` 900.80


(a) Material Yield variance = (1) – (2) = `53.35 (A) [`800 – `853.35]
(b) Material Mix variance = (2) – (3) = `6.65 (A) [`853.35 – `860]
(c) Material usage variance = (1) – (3) = `60 (A) [`800 – `860]
(d) Material price variance = (3) – (4) = `40.80 (A) [`860 – `900.80]
(e) Material cost variance = (1) – (4) = `100.80 (A) [`800 – `900.80]
Illustration 7
Material Standard Quantity Price Total

(Kg.) (`) (`)
A 500 6.00 3,000
B 400 3.75 1,500
C 300 3 900
1,200
5,400
Less: 10% Normal loss 120
1,080 5,400
Material Actual Quantity Price Total

A 400 6.00 2,400
B 500 3.60 1,800
C 400 2.80 1,120
1,300
5,320
Less: Actual loss 220
1,080 5,320
Calculate:
a. Material Cost Variance
b. Material Price Variance
c. Material Mix Variance
d. Material Yield Variance
e. Material Usage
Variance
Solution:
Amount (`)
SQSP (1) RSQSP (2) AQSP (3) AQAP (4)
A 3,000 541.67 x 6 = 3,250 400 x 6 = 2,400 2,400
B 1,500 433.33 x 3.75 = 1,625 500 x 3.75 = 1,875 1,800
C 900 325 x 3 = 975 400 x 3 = 1,200 1,120
5400 5,850 5,475 5,320

COST ACCOUNTING
Computation of RSQ
 500 
For A = x 1,300 = 541.67 units.
 1,200 
 
 400 
For B = x 1,300 = 433.33 units.
 1,200 
 
 300 
For C = x 1,300 = 325.00 units.
 1,200 
 
Where
1. SQSP = Standard Cost for Standard Material = ` 5,400
2. RSQSP = Revised Standard Cost of Material = ` 5,850
3. AQSP = Standard Cost of Actual Material = ` 5,475
4. AQAP = Actual Cost of Material = ` 5,320
a. Material Yield Variance = (1) – (2) = ` 450 (A) [`(5,400 – 5,850)]
b. Material Mix Variance = (2) – (3) = ` 375 (F) [`(5,850 – 5,475)]
c. Material usage variance = (1) – (3) = `75 (A) [`(5,400 – 5,475)]
d. Material price variance = (3) – (4) = `155 (F) [`(5,475 – 5,320)]
e. Material cost variance = (1) – (4) = `80 (F) [`(5,400 – 5,320)]
Illustration 8
A manufacturing concern which has adopted standard costing furnishes the following information.
Standard
Material for 70 Kg of finished product of 100 Kg
Price of materials Re.1 per kg
Actual
Output 2,10,000 kg.

Material used 2,80,000 kg.
Cost of materials ` 2,52,000
Calculate:
a. Material Usage Variance
b. Material Price Variance
c. Material cost Variance

Solution:
Amount (`)
(1) SQSP (2) AQSP (3) AQAP

[2,10,000 x 100/70] x 2,80,000 x 1
1
3,00,000 2,80,000 2,52,000
Computation of Required Variances:
a. Material Usage Variance = (1) – (2) = ` 20,000 (F)
b. Material Price Variance = (2) – (3) = ` 28,000(F)
c. Material Cost Variance = (1) – (3) = ` 48,000(F)
Illustration 9
The standard set for material consumption was 100kg. @ ` 2.25 per kg.
In a cost period:
Opening stock was 100 kg. @ ` 2.25 per kg.
Purchases made 500 kg. @ ` 2.15 per kg.

Consumption 110 kg.
Calculate: (a) Usage (b) Price variance
(1) When variance is calculated at point of purchase
(2) When variance is calculated at point of issue on FIFO basis
(3) When variance is calculated at point of issue on LIFO basis
Solution:
(a) Computation of Material Usage Variance
Material Usage Variance = SQSP – AQSP
= SP (SQ – AQ)
= 2.25(100-110)
= 22.50 (A)
(b) Computation of Price variance

(1) When Variance is calculated at the point of purchase:
Price variance = AQSP – AQAP
= (110 x 2.25) – (110 x 2.15)
= 11 (F)
COST ACCOUNTING
(2) When variance is calculated at the point of issue on FIFO basis

= (110 x 2.25) – ([100 x 2.25]+[10 x 2.15])
= 1 (F)
(3) When variance is calculated at the point of issue on LIFO basis
= (110 x 2.25) – (110 x 2.15)
= 247.50-236.50
= 11 (F)
Illustration 10
Using the following information calculate each of three labour variance for each department.
Dept X Dept Y
Gross wages direct (`) 28,080 19,370
Standard hours produced 8,640 6,015
Standard rate per hour (`) 3 3.40
Actual hours worked 8,200 6,395
Solution:
Dept. X : Computation of Required Values
SRSH (1) SRAH (2) ARAH (3)

3 x 8640 3 x 8200
` 25,920 ` 24,600 ` 28080
1. SRSH = Standard Cost of Standard Labour

2. SRAH = Standard Cost of Actual Labour
3. ARAH = Actual Cost of Labour
a. Labour Efficiency Variance = (1) – (2) = ` 1,320 (F) [` (25,920 – 24,600)]
b. Labour Rate Variance = (2) – (3) = ` 3,480 (A) [` (24,600 – 28,080)]
c. Labour Cost Variance = (1) – (3) = ` 2,160 (A) [` (25920 – 28,080)]
Dept. Y Computation of Required Values

Amount (`)
SRSH (1) SRAH (2) ARAH (3)

3.4 x 6,015 3.4 x 6,395
` 20,451 ` 21,743 ` 19,370
a. Labour efficiency variance = (1) – (2) = ` 1,292 (A)
b. Labour rate variance = (2) – (3) = ` 2,373 (F)
c. Labour Cost Variance = (1) – (3) = ` 1,081 (F)

Illustration 11
Calculate variances from the following:
STANDARD ACTUAL
INPUT MATERIAL (`)/KG TOTAL INPUT MATERIAL (`)/KG TOTAL
400 A @ 50 20,000 420 A @ 45 18,900
200 B @20 4,000 240 B @ 25 6,000
100 C @15 1,500 90 C @15 1,350
700 25,500 750 26,250
LABOUR HOURS LABOUR HOURS
100 @ `2 per hour 200 120 @ `2.50 per hour 300
200 woman @ ` 1.50 300 500 240 woman @ ` 1.60 384 684
25 Normal Loss 75 Actual Loss
675 26000 675 26,934
Solution:
Calculation of Material Variances

Amount (`)
(1) (2) (3) (4)
SQSP RSQSP AQSP AQAP
A 428.57 x 50 420 x 50
B 214.29 x 20 240 x 20
C 107.14 x 15 90 x 15
A 20,000 21,429 21,000 18,900
B 4,000 4,289 4,800 6,000
C 1,500 1,607 1,350 1,350
25,500 27,325 27,150 26,250
RSQ for
A = 400/700 x 750 = 428.67
units B = 200/700 x 750 =
214.29 units C = 100/700 x 750
= 107.14 units
1. SQSP = Standard Cost of Standard Material = ` 25,500
2. RSQSP= Revised Standard Cost of Material = ` 27,325
3. AQSP= Standard Cost of Actual Material = ` 27,150
4. AQAP = Actual Cost of Material = ` 26,250
a. Material Yield Variance (1-2) = ` 1,825 (A)
b. Material Mix Variance (2-3) = ` 175 (F)
c. Material Usage Variance (1-3) = ` 1,650 (A)
d. Material Price Variance (3-4) = ` 900 (F)

COST ACCOUNTING
e. Material Cost Variance (1-4) = ` 750 (A)

Calculation of Labour Variances
Amount (`)
(1) (2) (3) (4)

SRSH SRRSH SRAH ARAH
Men 2 x 107.14 2 x 120
Women 1.50 x 214.28 1.50 x 240
Men 200 214.28 240 300
Women 300 321.42 360 384
` 500 ` 536 ` 600 ` 684
RSH for
Men = 100/700 x 750 = 107.14 units.
Women = 200/700 x 750 = 214.28 units.
1. SRSH = Standard Cost of Standard Labour = ` 500
2. SRRSH = Revised Standard Cost of Labour = ` 536
3. SRAH = Standard Cost of Actual Labour = ` 600
4. ARAH = Actual Cost of Labour = ` 684
a. Labour Yield Variance (1-2) = ` 36 (A)
b. Labour Mix Variance (2-3) = ` 64 (A)
c. Labour Efficiency Variance (1-3) = ` 100 (A)
d. Labour Rate Variance (3-4) = ` 84 (A)
e. Labour Cost Variance (1-4) = ` 184 (A)


COST ACCOUNTING
6.3 BUDGET AND BUDGETARY CONTROL
The literary meaning of the word Budget is a statement of income and expenditure of a certain
period. In principle, the meaning is same in the context of business also. An individual will have his
own budget, a family, a local authority, state and country etc. All will have their respective budgets.
So also the business concern must have its budget so as to attain their objectives.
CIMA defines a budget as, “A budget is a financial and/or quantitative statement, prepared prior to
a defined period of time, of the policy to be pursued during that period for the purpose of attaining a
given objective.”
Features of Budget
An analysis of the above definition reveals the following as features of the budget.
(i) A Budget must be expressed either in quantitative form i.e., the number of units of different
products or it may be expressed in rupees of each product or it may be quantitative and
financial form i.e., the number of units and rupees of each product etc.,
(ii) It must be prepared before the time for which it is required, for example, if budget is required for
the year 2013-14, it must be prepared in the year 2012-13.
(iii) Budget must be prepared for a definite period.
(iv) Budget must be prepared in accordance with the policies of the business enterprise.
(v) Budgets are prepared normally for attaining organisational objectives, because policies are
formulated to achieve the objectives and those are translated into quantitative and financial form.
Objectives of the Budget
Essential elements of Budget
Limitations of Budgets
(i) Budgets fail if estimates are not accurate.
(ii) Risk of Rigidity
(iii) Budgeting is an expensive process.
(iv) Budgeting is not a substitute for management.
(v) Continuous monitoring is required.


COST ACCOUNTING
Classification of Budgets
Budgets are broadly classified based on :
(A) Time
(B) Nature of expenditure and receipts
(C) Functions
(D) Capacity
Let us discuss the budgets as per above classification in detail.
(A) ON THE BASIS OF TIME
(i) Long term budget: Though there is no exact definition of long term budget, yet we can
say that a budget prepared covering a period of more than a year can be taken as long
term budget. Of course, it may be for 3 years, 5 years, 10 years and even 20 years etc.,
(ii) Short term budget: It is a budget prepared for a period covering a year or less than a year.
(B) ON THE BASIS OF NATURE OF EXPENDITURE AND RECEIPTS
(i) Capital Budget: It is a budget prepared for capital receipts and expenditure such as
obtaining loans, issue of shares, purchase of assets, etc.,
(ii) Revenue Budget: A Budget covering revenue receipts and expenses for a certain period
is called Revenue Budget. Examples: Sales, other incomes, purchases, administrative
expenses etc.,
(C) ON THE BASIS OF FUNCTIONS
Functional Budget: If budgets are prepared of a business concern for a certain period taking
each and every function separately such budgets are called functional budgets. Example:
Production, Sales, purchases, cost of production, cash, materials etc.
Types of Functional Budgets
The following are the various functional budgets, some of which are briefly explained here under:
(i) Sales Budget: The sales budget is a forecast of total sales, expressed in terms of money or
quantity or both. The first step in the preparation of the sales budget is to forecast as accurately
as possible, the sales anticipated during the budget period. Sales forecasts are usually prepared
by the sales manager assisted by the market research personnel.

Factors to be considered in preparing Sales Budget

As business existence depends upon the sales it is going to make and therefore it is an important one to
be prepared meticulously. It is the forecast of what it can reasonably sell to its customers during the
period for which budget is prepared. The company’s profit mostly depends upon the ability to sell its
products to customers. In the present era it is indispensable to establish the demand for the product
even before it is produced. It is the sales order book that the company’s continuity depends upon. Also, a
reasonable degree of accuracy must be there in preparing a sales budget unless its sales are accurately
forecast, production estimates will also become erroneous. A good amount of experience must be
necessary to prepare the sales budget. Yet the following factors must be considered in preparing the
sales budget:
(a) The locality of the market i.e., domestic or export
(b) The target customers i.e., industry or trade or a section or group of general public etc.,
(c) The product portfolio i.e., the number of products offered and their popularity among the target
customers
(d) The market share of each product and its influence on the product portfolio and the total market
(e) The effectiveness of existing marketing policy on the current sales volume and value
(f) The market share of competitor’s products and their effect on the company’s sales
(g) Seasonal fluctuation in sales
(h) Expenditure on advertisement and its impact on sales
(ii) Production Budget: The production budget is a forecast of the production for the budget period.
Production budget is prepared in two parts, viz. production volume budget for the physical units
of the products to be manufactured and the cost of production or manufacturing budget
detailing the budgeted cost under material, labour, and factory overhead in respect of the
products.
Factors to be considered in Production Budget
Next to the sales budget, the main function of a business concern is the production and for this, a
budget is prepared simultaneously with the sales budget. It is the forecast of production during the
period for which the budget is prepared. It can also be prepared in two parts viz., production volume
budget for the physical units i.e., the number of units, the tonnes of production etc., and the cost of
production or manufacture showing details of all elements of the manufacture. While preparing the
production budget, the following factors must be taken into consideration:-
(a) Production plan
Production planning is an important part of the preparation of the production budget. Optimum
utilisation of plant capacity is taken by eliminating or reducing the limiting factors and thereby
effective production planning is made.
(b) The capacity of the business concern
It is to be ensured that the capacity of the organisation will coincide the budgeted production or
not. For this purpose, plant utilisation budget will also be necessary. The production budget
must be based on normal capacity likely to be achieved and it should not be too high or too
low.
(c) Inventory Policy
While preparing the production budget it is also necessary to see to what extent materials
are available for producing the budgeted production. For that purpose, a purchase budget
COST ACCOUNTING
or a purchase plan must also be studied. Similarly, on the other hand, it is also necessary to
verify the extent to which the inventory of finished goods is to be carried.

(d) Sales budgets must also be considered before preparing production budget because it may
so happen that the entire production of the concern may not be sold. In such a case the
production budget must be in line with the sales budget.
(e) A plan of the sequence of operations of production for effective preparation of a production
budget should always be there.
(f) Last, but not the least, the policy of the management should also be considered before preparing
the production budget.
Objectives and Advantages of Production budget

• Optimum utilisation of the productive resources of the organisation;
• Maintaining low inventory which results in risk of deterioration and fall in prices;
• Focus on the factors that are necessary to frame policies and plan sequence of operations;
• Projection of policies framed, on the basis of past performance, into the future to get the desired
results;
• To see that right materials are provided at right place and at right time;
• Helps in scheduling of production so that delivery dates are met and customer satisfaction is gained;
• Helpful in preparation of projected profit and loss statement, which is useful in evaluation of
performance and profitability.
(iii) Materials Budget: The material budget includes quantities of direct materials; the quantities of
each raw material needed for each finished product in the budget period is specified. The input
data for this budget is obtained by applying standard material usage rates by each type of
material to the volume of output budgeted.
(iv) Purchase Budget: The purchase budget establishes the quantity and value of the various items of
materials to be purchased for delivery at specified points of time during the budget period
taking into account the production schedule of the concern and the inventory requirements. It
takes into account the requirements for the entire budget plan as per the sales, materials,
maintenance, research and development, and capital budgets. Purchases may be required to
be made in respect of direct and indirect materials, finished goods for resale, components and
parts, and purchased services. Before incorporation in the purchase budget, these purchase
requirements should be suitably ascertained. Purchase budget also includes material
procurement budget.
(v) Cash Budget: Cash Budget is estimated receipts and expenses for a definite period, which usually
are cash sales, collection from debtors and other receipts and expenses and payment to
suppliers, payment of wages, payment of other expenses etc.
(vi) Direct Labour Budget or Personnel Budget: This budget is based on: (a) Production Budget, (b)
Sales Budget, (c) Capital expenses Budget, (d) Research and Development cost Budget, (e)
possibility of new wage agreements.
The main purposes of this budget are to: (1) help in the efficient labour management, (2) show
the planned outlay on direct and indirect wages.
(vii) Selling and Distribution Cost Budget: This budget is based on: (a) Sales budget, (b) Selling
and Distribution cost budget for the current period, (c) Actual selling and distribution costs for
the current period, (d) Expected changes in the rate of commission on sales, method of
distribution, advertisement policy, etc.

COST ACCOUNTING
(viii) Administration Cost Budget: This budget shows the total estimated cost of administration, i.e. cost
of formulating the policy, directing the organisation and controlling the operations. Most of the
expenses relating to administration are of ‘fixed’ nature within defined limits. This budget is
easy to prepare. Formally each budget centre or department prepares its own budget which
gets incorporated in this budget afterwards.
(ix) Capital Expenditure Budget: It is the planned outlay on fixed assets viz. Land, Building, Plant &
Machinery etc. during the budget period. This budget is generally prepared for a long period,
say 5 or 10 years. For control purposes, it is broken down into short periods. Preparation of this
budget is the responsibility of Head of Accounts, who will be assisted by the plant manager and
other functional heads, based on a number of information, e.g.
1. Plant utilisation budget
2. Long term business policy
3. Potential demand for certain products
On the basis of information a company may decide for extension factory capacity, purchase of
new and better factory equipments which will entail heavy capital expenditure.
(x) Research and Development Budget (R & D Budget): It is a planned outlay on R & D activities of a
company. The budget covers materials, equipments and supplies, salaries, expenses, and other
costs relating to design, development, and technical research projects.
Master Budget: Master budget is the budget prepared to cover all the functions of the business
organisation. It can be taken as the integrated budget of business concern, that means, it shows the
profit or loss and financial position of the business concern such as Budgeted Profit and Loss
Account, Budgeted Balance Sheet etc. Master budget, also known as summary budget or finalized
profit plan, combines all the budgets for a period into one harmonious unit and thus, it shows the
overall budget plan. The master budget incorporates all the subsidiary functional budgets and the
budgeted Profit and Loss Account and Balance Sheet. Before the budget plan is put into operation,
the master budget is considered by the top management and revised if the position of profit
disclosed therein is not found to be satisfactory. After suitable revision is made, the master budget is
finally approved and put into action. Another view regards the budgeted Profit and Loss Account and
the Balance Sheet as the master budget.

(D) ON THE BASIS OF CAPACITY

Difference between Fixed and Flexible Budgets
Fixed / Rigid Budget Flexible Budget

(i) It does not change with actual volume of It can be recasted on the basis of activity level
activity achieved. Thus it is known as rigid or to be achieved. Thus it is not rigid.
inflexible budget.
(ii) It operates on one level of activity and under It consists of various budgets for different levels
one set of conditions. It assumes that there of activity.
will be no change in the prevailing conditions,
which is unrealistic.
(iii) Here as all costs like – fixed, variable and Here analysis of variance provides useful
semi-variable are related to only one level of information as each cost is analysed
activity so variance analysis does not give according to its behaviour.
useful information.
(iv) If the budgeted and actual activity levels Flexible budgeting at different levels of
differ significantly, then the aspects like cost activity facilitates the ascertainment of cost,
ascertainment and price fixation do not give a fixation of selling price and tendering of
correct picture. quotations.
(v) Comparison of actual performance with It provides a meaningful basis of comparison
budgeted targets will be meaningless specially of the actual performance with the budgeted
when there is a difference between the two targets.
activity levels.
Principal Budget Factor

Budgets cover all the functional areas of the organisation. For the effective implementation of the
budgetary system, all the functional areas are to be considered which are interlinked. Because of
these interlinks, certain factors have the ability to affect all other budgets. Such factor is known as
principle budget factor.
Principal Budget factor is the factor the extent of influence of which must first be assessed in order to
ensure that the functional budgets are reasonably capable of fulfillment. A principal budget factor
may be lack of demand, scarcity of raw material, non-availability of skilled labour, inadequate
working capital etc. If for example, the organisation has the capacity to produce 2500 units per
annum. But the

COST ACCOUNTING
production department is able to produce only 1800 units due to non-availability of raw materials. In
this case, non-availability of raw materials is the principal budget factor (limiting factor). If the sales
manger estimates that he can sell only 1500 units due to lack of demand. Then lack of demand is
the principal budget factor. This concept is also known as key factor, or governing factor. This factor
highlights the constraints with in which the organisation functions.
BUDGETARY CONTROL
Budgetary control is defined as “the establishment of budgets relating the responsibilities of
executives to the requirements of a policy and the continuous comparison of actual with budgeted
results, either to secure by individual action the objective of that policy or to provide a basis for its
revision.”
Steps for Budgetary Control

From the above definition, the steps for Budgetary Control can be drawn as follows: -
(i) Establishment of Budgets
Budgetary control primarily aims at preparation of various budgets such as sales Budget, production
budget, overhead expenses budget, cash budget etc.,
(ii) Responsibilities of executives
The budgetary control system is designed to fix responsibilities on executives through preparation of
budgets.
(iii) Policy making
The established policies of the organisation are designed as budgets so as to fix responsibility on
executives.
(iv) Comparison of actuals with budgets
After establishing the budgets, the actuals are compared with them and any deviations, if any are
called variances.
(v) Achieving the desired result
The desired result of the budgetary control system is comparison of actuals with the budgeted
results and the causes of variances, if any, are analysed.
(vi) Reporting to Top Management
After the causes of Variances are analysed, the variances and their causes are reported to top
management so that the remedial action can be taken.
Advantages of Budgetary Control

(i) Budgetary control aims at maximisation of profits through optimum utilisation of resources.
(ii) It is a technique for continuous monitoring of policies and objectives of the organisation.
(iii) It helps in reducing the costs, thereby helps in better utilisation of funds of the organisation.
(iv) All the departments of the organisation are closely coordinated through establishment of plans
resulting in smooth functioning of the organisation.
(v) Since budgets fix the responsibilities of the executives, they act as a plan of action for them there
by reducing some of their work.
(vi) It facilitates analysis of variances, thereby identifying the areas where deficiencies occur and proper
remedial action can be taken.
(vii) It facilitates the management by exception.

(viii) Budgets act as a motivating force to achieve the desired objective of the organisation.
(ix) It assists delegation of authority and is a powerful tool of responsibility accounting.
(x) It helps in stabilizing the conditions in industries which face seasonal fluctuations.
(xi) It helps as a basis for internal audit.
(xii) It provides a suitable basis for introducing the payment by results system.
(xiii) It ensures adequacy of working capital to the organisation.
(xiv) It aids in performance analysis and performance reporting system.
(xv) It aids in obtaining bank credit.
(xvi) Budgets are forerunners of standard costs in the sense that they create necessary conditions to
suit setting up of standard costs.
ZERO-BASED BUDGETING (ZBB)

Zero-Based Budgeting (ZBB) is a method of budgeting which requires each cost element to be
specifically justified, though the activities to which the budget relates are being undertaken for the first
time, without approval, the budget allowance is ‘zero’. It is an activity based budgeting system in which
budget is prepared for each activity and the justification in the form of cost-benefits for the activity is
necessary to be given. The activities are evaluated and prioritised by the management based on the
factors viz. availability of funds, regulatory requirement, parity with organisational objectives etc.
ZBB involves various stages: (a) identification of decision packages and their description in detail,
(b) evaluation of decision packages, (c) selection of decision packages according to priority, and
(d) allocation of resources after approval of the budget committee and the top management.
Zero-based budgeting is better than traditional budgeting due to following reasons:
(i) It gives an opportunity for the management to allocate resources to various activities after a
detailed cost benefit analysis.
(ii) It helps the management to identify wasteful expenditure and eliminate them.
(iii) It also facilitates the management in linking the functional budgets with corporate objectives.
(iv) It facilitates introduction of a system of Management by Objectives (MBO).
RESPONSIBILITY ACCOUNTING
One of the recent developments in the field of management accounting is the responsibility
accounting, which is helpful in exercising cost control. ‘Responsibility Accounting is a system of
accounting that recognizes various responsibility centers throughout the organization and reflects
the plans and actions of each of these centers by assigning particular revenues and costs to the one
having the pertinent responsibility. It is also called profitability accounting and activity accounting.
It is a system in which the person holding the supervisory posts as president, function head,
foreman, etc are given a report showing the performance of the company or department or section
as the case may be. The report will show the data relating to operational results of the area and the
items of which he is responsible for control. Responsibility accounting follows the basic principles of
any system of cost control like budgetary control and standard costing. It differs only in the sense
that it lays emphasis on human beings and fixes responsibilities for individuals. It is based on the
belief that control can be exercised by human beings, so responsibilities should be fixed for
individuals.
COST ACCOUNTING
Principles of responsibility accounting are as follows:

(a) A target is fixed for each department or responsibility center.
(b) Actual performance is compared with the target.
(c) The variances from plan are analysed so as to fix the responsibility.
(d) Corrective action is taken by higher management and is communicated.
PERFORMANCE BUDGETING
Performance Budgeting is synonymous with Responsibility Accounting which means thus the
responsibility of various levels of management is predetermined in terms of output or result keeping
in view the authority vested with them. The main concepts of such a system are enumerated below:
(a) It is based on a classification of managerial level for the purpose of establishing a budget for
each level. The individual in charge of that level should be made responsible and held
accountable for its performance over a given period of time.
(b) The starting point of the performance budgeting system rests with the organisation chart in
which the spheres of jurisdiction have been determined. Authority leads to the responsibility for
certain costs and expenses which are forecast or present in the budget with the knowledge of
the manager concerned.
(c) The costs in each individual’s or department’s budget should be limited to the cost controllable
by him.
(d) The person concerned should have the authority to bear the responsibility.
Illustration 1
Prepare a Production Budget for three months ending March 31, 2016 for a factory producing four
products, on the basis of the following information.
Type of Product Estimated Stock on Jan. Estimated Sales during Desired closing stock on
1, 2016 Jan. to Mar. 31.3.2016
2016
A 2,000 10,000 3,000
B 3,000 15,000 5,000
C 4,000 13,000 3,000
D 3,000 12,000 2,000
Solution:
Production Budget for the 3 Months ending 31st March 2016
Particulars Product A Product B Product C Product D

Sales 10,000 15,000 13,000 12,000
Add: Closing Stock 3,000 5,000 3,000 2,000
13,000 20,000 16,000 14,000
Less: Opening Stock 2,000 3,000 4,000 3,000
Production (Units) 11,000 17,000 12,000 11,000

Illustration 2
Budgeted production and production costs for the year ending 31st December are as follows:
PRODUCT- X PRODUCT -Y
Production (units) 2,20,000 2,40,000
Direct material/unit ` 12.5 `19.0
Direct wages/unit ` 4.5 `7.0
Total factory overheads for each type of product (variable) ` 6,60,000 `9,60,000
A company is manufacturing two products X and Y. A forecast about the number of units to be sold in
the first seven months is given below:
MONTH JAN FEB MAR APRIL MAY JUNE JULY

Product – X 10,000 12,000 16,000 20,000 24,000 24,000 20,000
Y 28,000 28,000 24,000 20,000 16,000 16,000 18,000
It is anticipated that:
(a) There will be no work-in-progress at the end of any month.
(b) Finished units equal to half the sales for the next month will be in stock at the end of each
month (including December of previous year).
Prepare for 6 months ending 30th June a Production Budget and a summarised cost of production budget.
Solution:
Production Budget for 6 Months ending 30th June (Product X)
Particulars Jan Feb Mar Apr May Jun

Sales 10,000 12,000 16,000 20,000 24,000 24,000
Add: Closing Stock 6,000 8,000 10,000 12,000 12,000 10,000
16,000 20,000 26,000 32,000 36,000 34,000
Less: Opening
Stock 5,000 6,000 8,000 10,000 12,000 12,000
Production (units) 11,000 14,000 18,000 22,000 24,000 22,000
Total Production of X for 6 months = 11,000 + 14,000 + 18,000 + 22,000 + 24,000 + 22,000 = 1,11,000 units.
Production Budget for 6 Months ending 30th June (Product Y)

Sales 28,000 28,000 24,000 20,000 16,000 16,000
Add: Closing Stock 14,000 12,000 10,000 8,000 8,000 9,000
42,000 40,000 34,000 28,000 24,000 25,000
Less: Opening Stock 14,000 14,000 12,000 10,000 8,000 8,000
Production (units) 28,000 26,000 22,000 18,000 16,000 17,000
Total production of Y for 6 months = 28,000 + 26,000 + 22,000 + 18,000 + 16,000 + 17,000 = 1,27,000 units.

COST ACCOUNTING
Summarised Cost of Production Budget for 6 Months Ending 30th June

Amount (`)
Particulars Product X (1,11,000 units) Product Y (1,27,000 units) Total

Materials 13,87,500 24,13,000 38,00,500
Direct Wages 4,99,500 8,89,000 13,88,500
Variable Factory Overhead (wn) 3,33,000 5,08,000 8,41,000
Summarised cost of Production 22,20,000 38,10,000 60,30,000
Working Notes:
1. Computation of Variable Factory Overhead
 6,60,000 
For Product X =  2,20,000 1,11,000  = 3,33,000
 
 9,60,000 
For product Y=  2,24,000 1,27,000  = 5,08,000
 
Illustration 3
Draw a Material Procurement Budget (Quantitative) from the following information:
Estimated sales of a product 40,000 units. Each unit of the product requires 3 units of material A and
5 units of material B.
Estimated opening balances at the commencement of the next year:

Finished product = 5,000 units
Material A = 12,000 units
B = 20,000 units
Material on order:
Material B = 11,000 units
The desirable closing balance at the end of the next year:

Finished product = 7,000 units
B = 25,000 units
Material on order:
B = 10,000 units

Solution:
Production = Sales + Closing Stock - Opening Stock
= 40,000 + 7,000 - 5,000
= 42,000 units
Raw Materials Purchase Budget
Particulars Product A Product B

Material Required 1,26,000 2,10,000
(42,000 x 3) (42,000 x 5)
Add: Closing Stock 15,000 25,000
Add: Closing Stock on order 8,000 10,000
1,49,000 2,45,000
Less: Opening Stock 12,000 20,000
Less: Opening Stock on order 7,000 11,000
Raw Material Purchase 1,30,000 2,14,000
Illustration 4
From the following figures prepare the raw material purchase budget for January, 2017:
Materials
A B C D E F
Estimated Stock on Jan 1 16,000 6,000 24,000 2,000 14,000 28,000
Estimated Stock on Jan 31 20,000 8,000 28,000 4,000 16,000 32,000
Estimated Consumption 1,20,000 44,000 1,32,000 36,000 88,000 1,72,000
Standard Price per Unit 25 p. 5 p. 15 p. 10 p. 20 p. 30 p.
Solution:
Raw Materials Purchase Budget For January 2015
Type A B C D E F Total
Estimated Consumption (units) 1,20,000 44,000 1,32,000 36,000 88,000 1,72,000
Add: Estimated stock on Jan 31, 20,000 8,000 28,000 4,000 16,000 32,000
2017 (units)
1,40,000 52,000 1,60,000 40,000 1,04,000 2,04,000
Less: Estimated stock on Jan1, 2017 16,000 6,000 24,000 2,000 14,000 28,000
(units)
Estimated purchase (units) 1,24,000 46,000 1,36,000 38,000 90,000 1,76,000 6,10,000
Rate per unit (`) 0.25 0.05 0.15 0.10 0.20 0.30
Estimated purchases (`) 31,000 2,300 20,400 3,800 18,000 52,800 1,28,300

COST ACCOUNTING
Illustration 5
A company manufactures product - A and product -B during the year ending 31st December 2016, it
is expected to sell 15,000 kg. of product A and 75,000 kg. of product B at `30 and `16 per kg.
respectively. The direct materials P, Q and R are mixed in the proportion of 3: 5: 2 in the
manufacture of product A, Materials Q and R are mixed in the proportion of 1:2 in the manufacture
of product B. The actual and budget inventories for the year are given below:
Opening Stock Expected Closing stock Anticipated cost per Kg.

Kg. Kg. `
Material – P 4,000 3,000 `12
Material –Q 3,000 6,000 10
Material – R 30,000 9,000 8
Product - A 3,000 1,500 —
B 4,000 4,500 —
Prepare the Production Budget and Materials Budget showing the expenditure on purchase of
materials for the year ending 31-12-2016.
Solution:
Production Budget for the Products A & B
Particulars Product A Product B

Sales 15,000 75,000
Add: Closing Stock 1,500 4,500
16,500 79,500
Less: Opening Stock 3,000 4,000
Production 13,500 75,500
Material Purchase Budget for the Year ending Dec 31st 2016
Particulars P Q R Total
Material required for product A in the ratio of 3:5:2 4,050 6,750 2,700 13,500
Material required for product B in the ratio of 1:2 - 25,167 50,333 75,500
Total requirement 4,050 31,917 53,033
Add: Closing Stock 3,000 6,000 9,000
7,050 37,917 62,033
Less: Opening Stock 4,000 3,000 30,000
Purchases (in units) 3,050 34,917 32,033
Cost per Kg. 12 10 8
Total Purchase cost (`) 36,600 3,49,170 2,56,264 6,42,034

Illustration 6
The following details apply to an annual budget for a manufacturing company.
QUARTER 1st 2nd 3rd 4th

Working Days 65 60 55 60
Production (Units per working day) 100 110 120 105
Raw material purchases (% by weight of annual total) 30% 50% 20% —
Budgeted purchase price/Kg.( `) 1 1.05 1.125 —
Quantity of raw material per unit of production 2 kg. Budgeted closing stock of raw material 2,000
kg. Budgeted opening stock of raw material 4,000 kg. (Cost ` 4,000)
Issues are priced on FIFO Basis. Calculate the following budgeted figures.
(a) Quarterly and annual purchase of raw material by weight and value.
(b) Closing quarterly stocks by weight and value.
Solution:
Material Purchase Budget
Particulars Quarter 1 Quarter 2 Quarter 3 Quarter 4 Total
Production 6,500 6,600 6,600 6,300 26,000
(65x100) (60x110) (120x55) (60x105)
Material Required (Production x 2) 13,000 13200 13,200 12,600 52,000
Add: Closing Stock 2,000
54,000
Less: Opening Stock 4,000
Purchases by Weight 15,000 25,000 10,000 - 50,000
Computation of Purchases by Value

Particulars Quarter 1 Quarter 2 Quarter 3 Quarter 4 Total
Purchases (Weight) 15,000 25,000 10,000 -
(50,000 x 30%) (50,000 x 50%) (50,000 x 20%)
Cost per Kg. 1 1.05 1.125 -
Purchases (`) 15,000 26,250 11,250 - 52500
Budget Showing Closing Quarterly Stocks by Weight and Value

Particulars Quarter 1 Quarter 2 Quarter 3 Quarter 4
Opening Stock 4,000 6,000 17,800 14,600
Purchases 15,000 25,000 10,000 -
19,000 31,000 27,800 14,600
Material consumed 13,000 13,200 13,200 12,600
Closing Stock by Weight 6,000 17,800 14,600 2,000
Closing Stock by Value (`) 6,000 18,690 16,080 2,250
(6,000 x 1) (17,800 x 1.05) {(10,000 x 1.125)+ (2,000 x 1.125)
(4,600 x 1.05)}

COST ACCOUNTING
Illustration 7
You are required to prepare a Selling Overhead Budget from the estimates given below:
Amount (`)
Advertisement 1,000
Salaries of the Sales Dept. 1,000
Expenses of the Sales Dept.(Fixed) 750
Salesmen’s remuneration 3,000
Salesmen’s and Dearness Allowance - Commission @ 1% on sales affected
Carriage Outwards: Estimated @ 5% on sales
Agents Commission: 7½% on sales
The sales during the period were estimated as follows:
(a) `80,000 including Agent’s Sales `8,000
(b) `90,000 including Agent’s Sales `10,000
(c) `1,00,000 including Agent’s Sales `10,500
Solution:
Selling Overhead Budget
(`)
Sales 80,000 90,000 1,00,000

(A) Fixed overhead:
Advertisement 1,000 1,000 1,000
Salaries of the sales dept. 1,000 1,000 1,000
Expenses of the sales dept. 750 750 750
Salesmen remuneration 3,000 3,000 3,000
Total (A) 5,750 5,750 5,750
(B) Variable overhead:
Commission 720 800 895
(72,000 x 1%) (80,000 x 1%) (89,500 x 1%)
Carriage outwards (5% on sales) 4,000 4,500 5,000
Agents Commission 600 750 788
(8,000 x 7.5%) (10,000 x 7.5%) (10,500 x 7.5%)
Total (B) 5,320 6,050 6,683
Grand Total (A+B) 11,070 11,800 12,433

Illustration 8
ABC Ltd. a newly started company wishes to prepare Cash Budget from January. Prepare a cash
budget for the first six months from the following estimated revenue and expenses.
Amount (`)
Overheads
Month Total Sales Materials Wages
Production Selling & Distribution
January 20,000 20,000 4,000 3,200 800
February 22,000 14,000 4,400 3,300 900
March 28,000 14,000 4,600 3,400 900
April 36,000 22,000 4,600 3,500 1,000
May 30,000 20,000 4,000 3,200 900
June 40,000 25,000 5,000 3,600 1,200
Cash balance on 1st January was `10,000. A new machinery is to be installed at `20,000 on credit,
to be repaid by two equal installments in March and April, sales commission @5% on total sales is to
be paid within a month following actual sales.
`10,000 being the amount of 2nd call may be received in March. Share premium amounting to
`2,000 is also obtained with the 2nd call. Period of credit allowed by suppliers — 2months;
period of credit allowed to customers — 1month, delay in payment of overheads 1 month. Delay in
payment of wages
½ month. Assume cash sales to be 50% of total sales.
Solution:
Cash Budget for the First 6 Months

Opening Balance (A) 10,000 18,000 29,800 27,000 24,700 33,100
Add: Receipts (B)
Cash Sales (50%) 10,000 11,000 14,000 18,000 15,000 20,000
Collection from debtors - 10,000 11,000 14,000 18,000 15,000
Share call money (including share - - 12,000 - - -
premium)
Total (A+B) 20,000 39,000 66,800 59,000 57,700 68,100
Less: Payments
Materials - - 20,000 14,000 14,000 22,000
Wages 2,000 4,200 4,500 4,600 4,300 4,500
Overheads - 4,000 4,200 4,300 4,500 4,100
Sales Commission - 1,000 1,100 1,400 1,800 1,500
Installment of Machinery purchase - - 10000 10000 - -
Total Payments(C) 2,000 9,200 39,800 34,300 24,600 32,100
Closing Balance (A+B-C) 18,000 29,800 27,000 24,700 33,100 36,000
Note: According to credit terms wages to be taken at half of the current month plus half of the
previous month.
COST ACCOUNTING
Illustration 9
Prepare a Cash Budget for the three months ending 30th June, 2016 from the information given below:
(a) Amount (`)
MONTH SALES MATERIALS WAGES OVERHEADS

February 14,000 9,600 3,000 1,700
March 15,000 9,000 3,000 1,900
April 16,000 9,200 3,200 2,000
May 17,000 10,000 3,600 2,200
June 18,000 10,400 4,000 2,300
(b) Credit terms are:
Sales / Debtors : 10% sales are on cash, 50% of the credit sales are collected next month and the balance
in the following month.
Creditors: Materials 2 months
Wages 1/4 month
Overheads 1/2 month.
(c) Cash and bank balance on 1st April, 2016 is expected to be ` 6,000.
(d) Other relevant information are:
(i) Plant and machinery will be installed in February 2016 at a cost of ` 96,000. The monthly
installment of `2,000 is payable from April onwards.
(ii) Dividend @ 5% on preference share capital of ` 2,00,000 will be paid on 1st June.
(iii) Advance to be received for sale of vehicles ` 9,000 in June.
(iv) Dividends from investments amounting to ` 1,000 are expected to be received in June.
Solution:
Cash Budget for the 3 Months Ending 30th June 2016 (Amount in `)
Particulars April May June
Opening Balance 6,000 3,950 3,000
Add: Receipts :
Cash Sales 1,600 1,700 1,800
Collection from debtors [see note(1)] 13,050 13,950 14,850
Advance for sale of vehicles - - 9,000
Dividends from Investments - - 1,000
Total (A+B) 20,650 19,600 29,650
Less: Payments
Materials 9,600 9,000 9,200
Wages (see note2) 3,150 3,500 3,900
Overheads 1,950 2,100 2,250
Installment of Plant & Machinery 2,000 2,000 2,000
Preference Dividend - - 10,000
Total (C) 16,700 16,600 27,350
Closing Balance (A+B-C) 3,950 3,000 2,300

Previous Terms Question Papers
Working Notes:
(i) Computation of Collection from Debtors (Amount in `)
Month Credit
Total Sales Feb Mar Apr May June
Sales
Feb 14,000 12,600 - 6,300 6,300 - -
Mar 15,000 13,500 - - 6,750 6,750 -
Apr 16,000 14,400 - - - 7,200 7,200
May 17,000 15,300 - - - - 7,650
13,050 13,950 14,850
(ii) Wages payment in each month is to be taken as three-fourths of the current month plus one-
fourth of the previous month.
The Institute of Cost Accountants of India 433

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INTERMEDIATE : PAPER - 8

Study Note 2 : Cost Ascertainment - Elements of Cost

2.1 Material Cost (CAS-6) 29

Study Note 4 : Cost Book Keeping

4.1 Cost Accounting Records, Ledgers and Cost Statements 205

Study Note 5 : Methods of Costing

5.1 Job Costing 261

Study Note 6 : Cost Accounting Techniques

6.1 Marginal Costing 353

THE INSTITUTE OF COST ACCOUNTANTS OF INDIA 1

Costing : Costing is defined as the technique and process of ascertaining costs.

2 THE INSTITUTE OF COST ACCOUNTANTS OF INDIA

is a science because it is a systematic body of knowledge having certain principles which a

Scope of Cost Accountancy

THE INSTITUTE OF COST ACCOUNTANTS OF INDIA 3

Financial Accounting and Cost Accounting:

4 THE INSTITUTE OF COST ACCOUNTANTS OF INDIA

Cost Accounting and Management Accounting

Advantages of Cost Accounting

THE INSTITUTE OF COST ACCOUNTANTS OF INDIA 5

6 THE INSTITUTE OF COST ACCOUNTANTS OF INDIA

THE INSTITUTE OF COST ACCOUNTANTS OF INDIA 7

Material Labour Expenses

Direct Materail Direct Labour Direct Expenses

Indirect Material Indirect Labour Indirect Expenses

Direct Material + Direct Labour + Direct Expenses = Prime Cost

8 THE INSTITUTE OF COST ACCOUNTANTS OF INDIA

Direct Material Cost

Direct Labour / Employee Cost

Indirect Labour/ Employee Cost

Direct or Chargeable Expenses

THE INSTITUTE OF COST ACCOUNTANTS OF INDIA 9

1 THE INSTITUTE OF COST ACCOUNTANTS OF INDIA

THE INSTITUTE OF COST ACCOUNTANTS OF INDIA 11

1 THE INSTITUTE OF COST ACCOUNTANTS OF INDIA

Advantages of Cost Control

Cost Control Cost Reduction

THE INSTITUTE OF COST ACCOUNTANTS OF INDIA 13

1 THE INSTITUTE OF COST ACCOUNTANTS OF INDIA

Cost Classification by nature

Material Labour Expenses

Material Labour Expenses Material Labour Expenses

THE INSTITUTE OF COST ACCOUNTANTS OF INDIA 15

Indirect Material + Indirect Labour + Indirect Expenses = Overheads

(c) Classification by Functions

A business enterprise performs a number of functions like manufacturing, selling, research...etc.

(i) Production or Manufacturing Costs

(ii) Administration Costs

(iii) Selling & Distribution cost

(iv) Research & Development costs

Cost classification by function

1 THE INSTITUTE OF COST ACCOUNTANTS OF INDIA

THE INSTITUTE OF COST ACCOUNTANTS OF INDIA 17

1 THE INSTITUTE OF COST ACCOUNTANTS OF INDIA

(d) Classification based on Behaviour – Fixed, Semi-variable or Variable

Cost classification by behaviour

Fixed Variable Semi-variable

THE INSTITUTE OF COST ACCOUNTANTS OF INDIA 19

2 THE INSTITUTE OF COST ACCOUNTANTS OF INDIA